Legal Question in Real Estate Law in California

The bank is under no obligation to accept a short sale. Given that they know you have $500,000 available, they are unlikely to just say, "Oh, sure, we'll just take $500,000 less commission even though you owe us $570,000." But you can always try. If they accept your short-sale they cannot come after you for the difference. If they do not, they have to make a choice between a traditional foreclosure (which is really called a trustee's sale) or a court foreclosure. If they choose the trustee's sale, which has many advantages to them, they are prohibited from going after you for any shortage. If they choose a court foreclosure, the court sells the property and then enters a judgement against you for the difference. Whatever way the bank goes, if they are not paid in full they will issue you a 1099 for the amount they write off. Under the Internal Revenue Code that is taxable income to you, however, there is temporary legislation in place that puts a moratorium on that tax. I'm not sure if it ends this year or next.

I agree with Mr. McCormick, and would like to add that keeping $500,000 of business funds in the same bank where you have a mortgage you might default on is contrary to conventional wisdom and many would advise you to park the funds elsewhere, just in case the bank dreams up a right to offset or resorts to some similar tactic. You probably have access to a tax advisor who can give you the bottom line on a possible 1099-MISC; the income aspect of loan 'forgiveness' may either not apply due to the moratorium or you may have offsetting losses. The vast majority of foreclosures these days are by trustee sale, and that precludes the bank from seeking a deficiency judgment; the few exceptions mainly involve non-purchase money (refinance) loans or suits from holders of seconds who hale lost their collateral through foreclosure of the senior note. Another possible exception might be a borrower known to the bank to have deep pockets.