The year 2007 total for U.S. bankruptcy filings came to 850,912. Of those, 822,590 were personal bankruptcies (nonbusiness). By the end of 2010, the total jumped to 1,593,081. This year is on track for another 1.5 million bankruptcies. That’s about a 94% jump from when our economy was in good shape to where we find ourselves today.

The reason I bring this to light is that as a real estate investor you never want to become involved with the short sale of a property involved in a bankruptcy. The only time you combine a bankruptcy and a short sale is before the borrower declares bankruptcy. The genuine threat of bankruptcy as part of the borrower’s short sale hardship can convince a lender to approve a short sale.

Before going further, I want to be clear that I’m not offering any legal advice. I’m not an attorney and I don’t know the facts in your situation. I’m only sharing information. You need to check with a competent attorney regarding your situation.

Once the borrower files for bankruptcy, the short sale process becomes much to complicated to justify pursuing it. The bankruptcy filing stops all collection activities. A short sale is considered a collection activity. Instead of working only with the lender and borrower on the short sale, you now have to work with a court appointed trustee of the bankruptcy and the lender and the borrower.

If you think you have the perfect short sale property and want to go through the process, this is what you should expect. First you need to obtain a court document known as an “Affidavit of Abandonment for Real Estate and Asset”.

Obtaining that document requires proving to the court that the borrower has no equity in the property. You begin this process by collecting evidence such as contractor estimates, appraisals, market reports, and other supporting documents.

The objective is having the property excluded from the bankruptcy case to allow the borrower and lender to resolve the debt outside of court proceedings. Once the property is out of the bankruptcy case, the lender is free to begin or continue the foreclosure process. Even if you have a verbal short sale agreement with the lender, they still have the option to pursue foreclosure.

Another issue to consider is the cloud the bankruptcy places on the title. The Affidavit of Abandonment for Real Estate and Asset document is sufficient for the title company to convey clear title to you but it might take some effort on your part to convince them or they might limit title insurance if you purchase it.

The reason I’m strongly against mixing bankruptcies and short sales is there are too many down sides. There’s another issue you need to be aware of. If you sign any legal documents with the lender or borrower while the property is inside bankruptcy, it’s considered “fraudulent conveyance”. I don’t know all of the legal ramifications to this. However, at the least, it makes the agreement null and void because the property is under the control of the bankruptcy court. This isn’t likely to be an issue with the lender because they have a legion of attorneys advising them. However, the borrower is not likely to be aware of the issue.

Bottom line is there are too many good investment properties on the market today for investors to become bogged down trying to buy a short sale that is involved in a bankruptcy.