I have a house in Union City, CA and I am heading towards a short sale. I have not lived in this house since 2005 after my ex-boyfriend and I split. He continued to live at this location and I continued to pay a portion of the mortgage. We were 50/50 on the mortgage payments until he his wife moved into the house. Then they paid 75% $2,400 and I paid $800. He has now moved on and out of the house and has purchased another house. Leaving me with a house that is 200k underwater with the option of a short sale, foreclosure or bankruptcy. I would like to get out of this with as little damage to my assets as possible. Would a short sale with outs a deficiency judgment (if I can find a good negotiator) or a foreclosure a better choice in terms of state and federal and state taxes?
Since you are not living in the property, and have not for at least 2 of the prior 5 years, the house is not your personal residence. Therefore the tax treatment will be that of an investment property. You figure gain or loss based on the sale price of the property less the purchase price plus improvements. If you are substantially underwater it probably won't make any difference whether you walk away or negotiate a short sale, since both are considered to be a "sale" of the asset. If you are in partnership with another, there are additional considerations regarding the allocation of the loss.
Bottom line: Make the best deal you can, with the least financial and credit impact.
Please keep in mind that there are many variables that could be applied to the brief facts you have given. The information offered here is general in nature and is not a legal opinion nor is it specific tax advice.
Corporate / Incorporation Lawyer
As a Florida attorney I cannot opine directly on California law, however I do remember reading somewhere that California purchase-money mortgages are nonrecourse by statute. That means that if the mortgage that forecloses is the one you used to purchase the house (not a re-fi) you could not be sued for a deficiency judgment. This is important, because in a short sale the mortgage company will seek to have you execute a new note that would bind you personally. It is barely possible that you would somehow be better off doing that but in the vast majority of scenarios you would not. Don't sign anything like that without consulting an attorney. If you can't get a short sale through without obligating yourself, then it's time to go with a deed-in-lieu or a foreclosure.
As for whether you will suffer tax consequences from a disposition of the house, debt that is "forgiven" becomes taxable to you if you were personally responsible for it. California's nonrecourse situation may mean that it isn't proper for a lender to issue you a form 1099-c. However, that doesn't mean that they won't do it ... and you may need a tax professional to help you untangle that.
Even if a form 1099-c is properly issued, a form 982 calculation may reduce or eliminate its effect. Again, you may need a tax professional.