Short Sale Taxes

It's tax season, and taxes are on my mind.  I think taxes are super boring, and sometimes terrible.  Before we decided to sell our house for less than we owe, we went to a real estate lawyer.  It was our hope to avoid any potentially terrible/taxable/illegal things happening that we were not ready for.  We wanted to be informed.

If we short sell our house, the difference between what we owe, and what the buyer pays is potentially and usually taxable by the federal and state governments.  This seems silly as we would never see the cash, but it is because the government sees the difference as a 'gift' from the lender.  It would be a gift to be out from under an extravagant loan.

Fortunately, George Bush made a federal tax shelter on short sale income until December 2010.  The state can tax the difference if the house is not your primary residence and you have lived in it less than 2 years.  It seems as if we are in the clear on the tax front, but nothing is a sure thing.

If we are taxed on the difference, the tax will be negligible compared to the extreme cost of the loan and house we currently live in over the lifetime of the loan, or until we could sell and make money (in 37 yrs. looking at statistics).  We are having faith that this might work out, and by faith, I mean faith with a lawyer as an angel.