Santa Barbara Association of REALTORS®:
"Q 1. Are foreclosures, deeds in lieu of foreclosure, and short sales subject to federal tax income taxation? A Yes. However, the income is taxed differently depending on several factors, including whether there was a foreclosure, a deed in lieu of foreclosure given to the lender, or a short sale (a sale where the lender agrees to reduce the amount owed in order to facilitate a sale), and whether the underlying debt is “recourse” (the borrower is personally liable for the debt) or “nonrecourse” (the borrower is not personally liable for the debt). For federal income taxation as a result of foreclosure, see generally 26 U.S.C. §§ 1001 through 1016. For federal income taxation of short sales, see generally 26 U.S.C. §§ 61, 108 and 1001 through 1016. TAXATION OF FORECLOSURES OR DEEDS IN LIEU OF FORECLOSURE
Q 2. What is the difference between a foreclosure and a deed in lieu of foreclosure? A A foreclosure refers either to a trustee’s sale foreclosure (not a judicial proceeding) or to a judicial foreclosure (a judicial proceeding). A deed in lieu of foreclosure means that the lender has agreed to accept title to the property and the borrower transfers title to the lender rather than waiting until the lender forecloses on the property. A deed in"
This is an excellent summary of the law by the legal department at the California Association of Realtors.
The implications of short sale will be discussed in the next blog.