If someone does a short sale on a multi-unit can they exclude the cancelled debt from ordinary income? Does it fall under the "Qualified Real Property Business Indebtedness" clause shown in Pub 4681? Note: They are not insolvent nor filing bankruptcy under Title 11. Clent paid $400,000 each for 3 separate 4-plexes in 2005. Can not continue to make payments so he wants to list them for sale but they're only worhth around $250,000 now. The bank would have to aprove a short sale. If he still owes $350,000 on his loans and the bank accepts a contract for $250,000, will the bank issue a 1099-C for the difference? What would be the tax consequence of this action? I.E. Cancelled debt taxable as ordinarry income and / or Adjustment of Cost Basis? We have many clients facing real estate problems with this market. With the Personal Residence I believe the Cancelled Debt can be excluded as long as it does not exceed the amount that was used to either purchase or improve the home. But Not sure how the Investment properties are handled.