You need to consult a real estate attorney and a CPA for this. These questions are just outside the scope of what we can answer. We cannot give legal advice. I would begin with my CPA if I were you.

There are two possible ways a bank might handle the shortage:

1.) File for a deficeincy judgment gainst you for the amount of the loss. Some states bar deficeincy judgments; I don't know if California is one of them.

or

2.) Forgive the loss and report it to the IRS as taxable income.

If option 2 is excercised, you may be able to avoid income tax on the forgiven debt if it was used to buy or substantially improve your home. Here is a link to IRS info about avoiding the tax:

http://www.irs.gov/individuals/article/0,,id=179414,00.html

As I understand it, if it not agreed upon in writing that you will not pay the deficient amount, you will be 1099 on that amount of the loss. Which totally sucks!!! Unless Big Brother steps in and does something for the 100's of thousands of people who are in this predicament. The banks dont loose because they right it off, The Govt doesnt looks because of the taxes, guess who looses.....

So write your congressman and tell em to do something and pass a bill to diminish or forgive the deficient balance. For now... the consumer is on the hook, as always...

I have clients, family members, collegues all asking the same questions...

If possible, negotiate the bank to forgive the dfference.. You dont get what you dont ask for but its highly unlikley...

We have come up with some solid solutions.. drop me an email if you need more infor..This board will provide you with a smorgasborg of assistance.

Good Luck..