Legal Question in Real Estate Law in California

You might or might not be taxed in either case depending on what the bank does. In a short sale, the lender may elect to sell the balance of the loan to a collection agency, or they may write it off. If they write it off, they will have to issue you a 1099 for the difference in order for it to be a loss on their taxes. So you would be taxed. In a foreclosure, if they bid in the full amount of the debt, called a "full credit bid," then they have no recoginzable loss and you pay no tax. Likewise if it sells to a third party for the amount of the debt you pay no tax. If the bank only bids in part of the debt and takes the balance as a tax write-off to them, they will 1099 you and you pay tax on the balance. Basically it is all driven by the bank's taxes. If they want a write-off, they must call it income to you and you get taxed.