Short selling is a term used to describe the act of selling your property below its original purchase price. Short selling has become increasingly common since the real estate bubble burst, sending property values plummeting to levels that had been unheard of for years. The sad fact of the matter is that many property owners who bought property during the boom years had no choice but to short sell it or face foreclosure. So, if you intend to sell a rental property, you will need to understand how the short selling works, what it means for your mortgage and how it affects your taxes.

Calculate the Current Rental Property Value

Before you sell your rental property, you will have to verify that it's worth what you think it's worth. If you are selling the property through a broker, he or she will calculate it for you. If you don't have a broker, you will have to hire a licensed real estate appraiser to handle the calculations. Failing that, you can try to approximate your property value by looking up the sales prices for the real estate properties similar to yours (and that are located in your property's area) that were sold over the past few months and calculating the medium value.

Calculate Closing Costs

Your next step should be to figure out the closing costs--the combined sum of fees necessary to finish the sale. If you have a broker, he or she can calculate that. Otherwise, you can consult your local title company or a real estate attorney.

Once the property value and closing costs are calculated, you can put your rental property up for sale. Be upfront about the fact that you are making a short sale. While it might put off some buyers, it will make it less likely that the buyers who are interested will pull out.

Get the Mortgage Lender's Consent

Once you find a potential buyer, you will have to contact the mortgage lender to get permission to proceed with the sale. If you sell your property as a short sale, the lender will lose money. As the result, lenders tend to be reluctant about letting you sell your rental property unless you can prove you won't be able to repay your mortgage loan in full.

To do this, you will have to contact your lender, find out who is responsible for handling short sales and get his or her contact information. Make sure that this is a specific supervisor rather than the short sales department in general. Once that's taken care of, you will use the contact information to submit the following documents:

• Letter of authorization--This is a letter that authorizes the lender to disclose your loan information to the real estate professionals that will be involved in the sale. The letter should include your name, the address of the property, your loan reference number and your agent’s name and contact information.
• Preliminary net sheet--This is a statement that should include sale price and estimated closing costs, the outstanding payments due and late fees.
• Hardship letter--This letter explains why your financial situation compels you to make a short sale and doesn't leave you with enough resources to repay your loan in full.
• Sales documents--This includes the copy of the buyer's offer and the copy of your listing agreement.

Once the documents are submitted, the short sales supervisor will decide whether to allow a short sale. However, their agreement may be conditional. Since the sale cannot proceed without lenders' permission, lenders can alter terms and conditions of the sale for their benefit (even if it sabotages the sale), and there is nothing you can do about it.

Tax Implications

You have a right to deduct capital losses--the loss of profit from your rental property over the past tax year. However, you will not be able to deduct any expenses involved in the short sale, including the difference between the purchase price and the sales price. Furthermore, if you owned your rental property for more than 11 years, you will have to pay a 25 percent depreciation recapture tax.