Your tax adviser can tell you whether the MFDRA applies. Be careful about the documentation of the short sale ... many lenders try to slip something in that has you reaffirming your liability for the deficiency balance. In some cases, lenders won't agree to the short sale without it. If that happens, you need to evaluate your legal and practical position very carefully to decide whether to sign on the dotted line, negotiate further, or just walk away.
Probably not, under both CA & federal law, which both have programs to forgive many discharged mortgages -please see the link below.
Also, what's the cost basis in this property? If the cost of your purchase, improvements. etc. in the property exceed the sales price, you wouldn't have any gain to pay tax on anyway.
See your CPA to make sure your return reflects all available legal forgivenesses.
Disclaimer: Please note that this answer does not constitute legal advice, and should not be relied on, since each state has different laws, each situation is fact specific, and it is impossible to evaluate a legal problem without a comprehensive consultation and review of all the facts and documents at issue. This answer does not create an attorney-client relationship.
Since this is your primary residence, you will not have to pay taxes on income from debt relief .
Any individual seeking legal advice for their own situation should retain their own legal counsel as this response provides information that is general in nature and not specific to any person's unique situation. Circular 230 Disclaimer - Advice given in this response cannot be used to eliminate penalties with the IRS or any other governmental agency.
The other answers are correct assuming that you can show that all the initial loan proceeds were used to either acquire or improve the property. If you took out a line of credit or refinanced the property, and took out additional dollars which was not used to improve the property would not qualify. However, there could be other exceptions under Section 108 of the Internal Revenue Code, such as the insolvency exception. You may want to consult with an accountant or tax counsel.