Is my short sale transaction taxable?
Sellers Answers

In most cases it is., but only the amount that the bank discounts from the original debt. For example, if you owe $300,000 to the bank and you sell you house for $280,000, the bank will lose $20,000 and give you a 1099 form for the amount of $20,000 which according to the I.R.S. is taxable income to you.

If the property in question is your primary residence and you have lived in it at least two years or you were financially insolvent in the year of the short sale then the 1099 form that you receive from the mortgage company is not taxable. In most cases, you, the seller, home owner is financially insolvent. This is the reason you are doing the short sale and your short sale is non taxable.

See additional short sale gain consequences and calculations.