If the short sale was your personal residence, and the debt was purchase money debt (your post leads me to believe otherwise), you have no taxable income. The Mortgage Forgiveness Debt Relief Act of 2007 made a temporary change in the law, to generally exclude personal residence debt relief from income. It does, however, reduce your tax basis in the property, so if you had significant cash out refi’s or a very low down payment, there may be some taxable capital gain. (the exclusion on personal residence capital gains not withstanding)
Additionally, forgiveness of debt is not taxable to the extent the taxpayer is insolvent. If your debts exceed your assets, after the forgiveness, you have no taxable income as a result of the forgiveness. This is without regards to whether you file for bankruptcy protection.
If it was investment property, it’s a whole different story. And if it’s investment property, you shouldn’t be soliciting advice on a blog. You should either know the answer or getting professional advice from someone who does. That would not include a real estate broker, or a agent, or even an experienced investor. Unless they also happen to be CPA’s or tax attorneys.
