condos - underwater vs payoff

Over the past several years, we have inhereited several "family" real estate properties; each with their own unique set of circumstances, title, etc - We'll skip the complex details, and only address the most recent coin toss.
One of the houses in the Chicago area has an offer, and should close - hopefully. This is totally paid off, and inhereited by the brothers & sisters.
There are 2 condos in downtown Chicago - an area called River City - They are underwater with respect to the mortgage... purchased around 2005.
Several in the building have sold using Short Sales, so the comps look really bad... Here are the incomes vs expenses listed below...
Should we take the proceeds from the house sale & pay off the mortgages & continue to hold, or what other strategy might we investigate ???
Unit A - mortage = $133k, worth about $100k rent = $1150 mortgage = $1070, assessment = $515, taxes = $275
Unit B - mortage = $125k, worth about $95k rent = $1175 mortgage = $970, assessment = $480, taxes = $275
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No Good Deed -
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I'm not sure this is the best forum for your question, but in fairness to you it spans several including legal and tax. I'll try to give you some basic info BUT you really should get all the siblings together and meet with a tax pro in your area to discuss this in detail. Then be prepared to meet with an attorney. Also, each sibling may well be in a different position financially and each will be impacted differently by what is ultimately done. Do keep in mind that I am not an attorney, do not play on TV or this NG and am not giving you legal advice.
First - you need to determine how the properties are legally titled. Are they held in individual names - Jane Doe, Jim Doe & John Smith, Tenants in Common (or Tenants with Rights of Survivorship) - or are they held in the name of an LLC or Partnership - like The Smith Family LLC. How they're titled will matter.
Second - a short sale result in cancellation of debt income. Essentially you're selling the property for less than you owe, the bank writes off the shortage and issues (usually) a 1099-C to report the cancelled debt. That debt IS taxable income to the extent that the owner(s) are either insolvent or bankrupt. This is where title starts to matter.
Assume that there are 5 siblings, each owing 20% of a property worth $100K with a mortgage of $210K. The property is upside down by $110K OR $22K for each sibling. If you short sell the property the bank will eat the $110K and will issue a 1099-C to someone. If the property is titled in individual names the bank will MOST LIKELY issue the 1099-C to whoever is named first on the mortgage, if its owned by an LLC or partnership the 1099-C will go to the LLC and get passed through to the individuals.
Whether the cancellation of debt income is taxable will get determined at the individual level. So one sibling may be solvent and have to pay tax while other siblings may be insolvent and may not have to pay tax. Either way the IRS is going to get notified that someone has phantom income to report.
Third, and collateral to the cancellation of debt income issue - whose name is the mortgage in? If there are multiple owners named (all the siblings) the bank may not agree to a short sale without some verification of the financial status of the individuals. If the mortgage is in the name of an LLC they bank may want info on the financial status of the LLC - banks tend to treat businesses under stricter guidelines than they do individuals under the assumption that businesses are more knowledgeable and sophisticated. I will NOT address that assumption, just be aware that it does exist.
So IF the bank allows a short sale everyone needs to be prepared to deal with the cancelled debt income on their individual returns in one way or another. If the bank finds out or knows that the owners (either individually or as an LLC) are not only solvent but have or recently received cash from a recent sale, do not be surprised if they don't accept a short sale.
Fourth - NOW you have to decide if you want to keep the property and pay it off or keep the mortgage. That is the investment question. Are the properties a good investment? If so you may want to keep them, if not you should dump them. You almost have to back into this answer since you need to know whether the bank will allow a short sale.
Another option would be to ask the bank about settling the mortgage for less than face value if you pay it off - essentially short selling to yourselves. If the bank is concerned about you short selling the property and you offer them a cash buyout for less than face value you'll still have cancellation of debt income, but perhaps less than in a real short sale. IF doing this make the properties a good investment for then this may be an option.
Lastly, keep in mind that short selling will result in a note on someone's credit report, again depending on how the mortgage and deed are written. It is entirely possible that the 1099-C gets issued to ONE sibling and that sibling's credit report gets dinged while the other siblings get nothing reported to their credit files. This wouldn't relieve them of the tax liabilities, just the credit reporting issue - again, all of this DEPENDS on how the properties are titled and who's name the mortgage is recorded in.
And your jurisdiction matters. I am not familiar with Illinois law, not being an attorney. The tax consequences won't change. See now why I said you'll need to meet with a local pro first.
Good luck and please keep us posted about what you find out.
Gene E. Utterback, EA, RFC, ABA
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Gene E. Utterback, EA, RFC, AB
Just wanted to say thanks for the detailed list of "thoughts". I had not really dug into the nits of the Short Sale and the 1099-C along with the reported "debt income".
If and when the house hopefully actually closes, then we'll see what scenarios are avail at that time.
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