How to avoid a tax liability selling a house below what you owe?

If the mortgage is non-recourse, no problem.

If the mortgage is recourse, problem. If you write the lender a check for the $60K, they won't have any problems, but you will have to pay.

If the mortgage is recourse and you don't pay, they can sue you. If they eventually write off the debt, the IRS will see it as possible income unless you meet an exception. See IRS pub 4681 and form 982. The mortgage debt relief act only applies to acquision debt and expires at the end of 2013.

Please remember, you borrowed money from the bank, not the house. They don't want the house back and a short sale is not their fault either.

You really need to talk to the banker that has agreed to the short sale. A $60k loss may not be acceptable. Get it in writing that the difference will not be payable. And make sure you are not going to owe taxes on that $60k in 'forgiven' debt income.

You should have submitted an insurance claim on the vandalism. The proceeds of that claim should go to making repairs. After repairs are made the sales price could be raised to a level the bank will accept.

You may not owe any taxes in a short sale. (This is a short sale, right?).

Check with your own tax pro.

If it is your primary residence there is no tax on it due to the american recovery act. It expires at the end of this year unless renewed again.

sounds like there will be no gain on this sale and you cannot claim a loss on sale of your house(nor are you taxed on it)