Deficieny Judgement & Taxes!
From what I understand, an important part of a short sale is to get acceptance from the lender subject to waiver of a deficiency judgement against the person in foreclosure, so that the bank cannot sue them. But the foreclosee still needs to worry about taxation right?
100K second mortgage, say you work them down to 20K. The deficiency is 80K, which you get wavied, but now the IRS can still tax that 80K on the foreclosee. What is the taxation rate? Between 5%-10% so they would still owe the IRS 4000-8000K come tax time? 
That's a good question come to think of it. From what I understand the bank has to issue a 1099 (I think that's the right one) and then it's treated as income. Not, appreciation on a home for which you get a 250 K (500K if married) exemption if it's your primary. So it would be as if their salary was 80 K + any other taxable income they made that year.
The only solution I see is that you offer to pay the taxes for the guy.
By the way. You said second mortgage. What happened with the 1st? Is it paid off?
Roger
Yes, but as you know, the biggest discount is taken with the 2nd because they have 2nd position. THanks for the answer.
If a mortgagee agrees to forgive a portion of debt, they usually issue an IRS form 1099 that discloses the amount of forgiven debt. The IRS treats forgiven debt as income subject to tax.
However, sometimes, and in the majority of instances, the 'income' is exempt from tax. The IRS imposes several 'tests' to determine if all, or a portion of that forgiven debt/income is taxable.
As I stated, it's usually a non-issue. It's a good idea to prepare the (former) homeowner that they will likely receive the 1099...and advise the (former) homeowner that an accountant whose practice includes 'poor folk' should be able to navigate the exemption.
Bye the way, should you have any homeowners who haven't filed an income tax return in a few years... let me know. You'll probably need to furnish their tax returns as part of the short sale application.... and I may be able to help them get a refund.... even if they have had little, or no withholding.