Real estate terminology changes with the market. REO’s (Real Estate Owned, i.e. owned by banks), short sales and foreclosures are terms of the day as the market deals with an oversupply of homeowners unable to keep pace with rising loan payments and falling home values.

Common terminology in the world of stock trading, the “short sale” in real estate is a far more complex activity.

A short sale comes about when the “market value” of the home is lower than the outstanding debt on the property. It is not uncommon today to find a Napa Valley home where the contract value is $400,000 and the total outstanding debt is $425,000.

Buy obtaining a commitment from the lender to reduce the debt and accept a loan payoff of $400,000, the seller can proceed to closing the sale of the home. The seller/borrower benefits by avoiding a foreclosure action and the lender benefits by avoiding a long foreclosure process in which they might be confronted with ownership of the home and even greater losses.

As if the stress of a short sale was not enough, it is important that the seller be cautious to not incur a tax liability by paying off less than the original note amount.

Prior to the Mortgage Forgiveness Debt Relief Act of 2007, the home owner would be obligated to the federal government to treat the forgiven part of the debt as taxable income. Because of the financial hardships created by the sub prime mortgage failures, the federal government created criteria under which the tax liability associated with a short sale was removed. It is unclear if the State of California will be as forgiving.

The law only applies to your “principal residence” defined under Section 121 of the IRS Code as “during the 5-year period ending on the date of the sale or exchange, such property has been owned and used by the taxpayer as the taxpayer’s principal residence for periods aggregating 2 years or more.”

The maximum amount of forgiven debt is the rather generous amount of $2 million for married couples filing jointly and $1 million for single tax payers. The effective date of the forgiveness of the federal tax obligation on a mortgage reduction is on or after Jan. 1, 2007. Contact your tax advisor or Certified Public Accountant to obtain a clear explanation on the implications of your individual circumstance.

All of these “short sale” technicalities do not take into account the difficult and sensitive negotiations required to have the lender realize the benefit of reducing the payoff amount they are due and to have the seller realize the benefit of keeping a foreclosure off their credit history.

If you are considering embarking on the sale or purchase of a home that will require a short sale (value of the home less than the current debt), you are well advised to consult your Realtor to determine (1) the amount of the deficit and (2) the likelihood of obtaining a loan reduction and (3) the expected time and logistics for creating a successful sale.

Making the best of a difficult and less pleasant circumstance, the more negotiation experience your agent has the greater your odds for a successful sale.

Charles Bogue is a broker with Coldwell Banker Brokers of the Valley in Napa. He can be reached at 258-5221 or e-mail: cbogue@cbnapavalley.com