I ran across this article and found it extremely informative in describing the different potential tax consequences and laws that are in place for short sales and foreclosures, specifically in California. It was written by a CPA who (of course) advises you to consult an attorney to understand your specific situation. It goes into a lot of detail on how the IRS looks at short sales and foreclosures and gives examples on how different scenarios could affect you. It isn't a "light" read but worth it if you want to educate yourself on this topic.
http://www.realestateinvestingtax.com/shortsale.shtml
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