Posted by JT-IN on June 12, 2007 at 15:14:41:
Regardless of who occupies the property. Debt relief is taxable income to the recipient of the relief, unless the debt has been discharged in Bk… or prior to the relief of the debt, the debtor is insolvent. Insolvent is defined as liabilities exceeding ones assets, or a negative net worth.
You can read about this in the IRS Publ 544, pg 4 and 5.
Debt forgiveness is reported on Form 982. You can walk thru the form and calculations at the link below, which may help you to follow the logic here.
Keep in mind that most people who qualify for a short sale, have no collectible assets. Otherwise the lenders usually will refrain from granting relief if other assets exist. Taxation on short sales is WAY overblown. Good luck. JT