Was all of the money used as purchase money? (Meaning you did not pull money out of the home and use it for other things on a re-fi.) If it was all purchase money, you may not have to pay any taxes on a short sale under the Mortgage Debt Relief Act. More info on the site below. Good luck!

Please contact an attorney to be sure! I am not qualified to give legal or tax advice!

I'm not a tax professional or attorney but here's my answer based on previous experience with short sales:

If your bank decides to report the difference of what they receive from what's owed they could report that difference as miscellaneous income and you'll be taxed at whatever tax bracket you fall into. For example, if the difference is $30,000 and you're in the 15% tax bracket, you'd have to pay $4,500 in income taxes for that short sale.

As bad as that sounds it's better than the alternative... the bank placing a judgment against you for the difference (in the above example it'd be a $30,000 judgment). My best advice to you is to seek additional legal counsel in conjunction to the advice provided by your real estate agent (unless your agent is also a lawyer).

Best of luck.

Liz
I am very sorry for your situation.

It sounds to me from your post that you really could use some good advice. I do not practice real estate in your area but I could refer you to someone that might be able to refer you an expert in short sales and foreclosures.

Feel free to contact me via my Trulia profile. You do have options, but time is of the essence.