This is Part II in a Series on Short Sales. See Part I, Buying Short Sales.

Due to certain conditions pursuant to the Mortgage Forgiveness Debt Relief Act of 2007, the I.R.S. could consider debt forgiveness as income to the seller/borrower, and there is no guarantee that a lender who accepts a short sale will not legally pursue a seller for the difference between the amount owed and the amount paid. This amount is known as a deficiency. Whether you are a buyer or seller, always obtain legal and accounting advice from competent professionals.

General Principles for Sellers:

Not an easy alternative to foreclosure – The deficiency will be accounted for in some fashion. It can be 100{0a8e414e4f0423ce9f97e7209435b0fa449e6cffaf599cce0c556757c159a30c} loaned to the seller in the form of a promissory note, which they then must repay. If any portion of the deficiency is “written off” meaning that the bank absorbs it, it will likely be reported it as 1099 income to the seller or even as a judgment which will show on the sellers credit for years.

Cumbersome process – If you are entering into a short sale as a buyer or seller, don’t expect it to go as quickly as any other sale. There’s a lot of “back and forth.”

Lender’s goal – The employees of the lender who are negotiating the sale are not there for the benefit of the seller. Their only goal is to collect as much money possible for the lender.

Effect of a short sale on a seller’s credit report – The ding on credit may show up as a pre-foreclosure in redemption status, which could result in a loss of 200 to 300 points.

Falling market values – The seller need not necessarily be in default before a lender will consider a short sale. A lender may consider a short sale if the seller is current yet value have fallen significantly.

Notice of Default – Lenders almost never will accept short sale offers or requests for short sales until the borrower is far behind in payments and a “notice of default” (see Part I) has been issued.

Bankruptcy – Few lenders will consider a short sale when the seller has filed for bankruptcy because negotiating a short sale is considered a collection activity and collection activities are prohibited in bankruptcies.

Stringent qualifications – Sellers must prove a hardship and submit evidence of the hardship to the lender for approval. Some agents list homes as short sales without ever talking to the lenders or pre-qualifying the sellers.

Reference: http://homebuying.about.com