Before I continue, I need you to know that I am not an attorney, nor am I a tax professional. Please, before you make any decisions about your housing situation, consult a professional to have your questions answered.
There are 2 major potential financial consequences of a short sale. The first is a potential deficiency judgment, and the second is the tax liability.
Short sales can damage your credit, and as a result, there may be other financial consequences of a smaller magnitude, but the two big ones are deficiency and tax liability.
Deficiency
Any time a lender is paid less than they are owed, there is a risk that they could sue you for the difference, plus miscellaneous legal fees, etc. If you bail on a $100,000 home that’s only worth $60,000 and your lender sells it at auction, there’s an outstanding $40,000 that someone will have to absorb. In many cases, Arizona’s anti-deficiency statute may protect you from a future judgment, but that’s dependent upon the conditions surrounding the purchase of the home.
Tax Liability
Any time debt is forgiven for less than the amount owed, the amount forgiven is considered income, and it’s your responsibility as a tax-payer to report that amount to the IRS as income. Whether or not your taxable income will be affected by this amount is completely dependent upon factors that I am not an expert in discussing, but it is possible that you may owe income tax on that amount. Why is it considered income? If you go back to the point at which your lender funded the purchase of your home, the money came “in” to your transaction. Forgiveness of that debt later would be just like a lender giving you money. So it becomes income.
