Many homeowners do not realize that they may be in store for a large tax bill from the IRS after the short sale of their home. Every situation is different and you should absolutely contact an accountant or tax advisor before conducting a short sale to determine your potential liability.   After the sale of your home any deficiency, any amount the bank is short, they will have to write-off on their end. To do that properly they will submit a 1099-C to you for the balance you owed that you were unable to pay back. The IRS may look at this as additional taxable income.

What are the odds that you have that kind of money laying around after you just went through a short sale on your home? Be very careful regarding your tax obligations BEFORE you consider a short sale, deed-in-lieu-of-foreclosure or foreclosure.

The IRS will use your tax basis on your property to determine your tax obligations so you must be able to figure this amount out.
 

See our article on IRS Form 982. The form is used to request a "reduction in tax attributes" due to insolvency. This may allow you to avoid having to pay taxes on the debt relief you experience with a short sale. Definitely worth talking to a tax attorney or accountant about!