How long does a short sale take from receiving a contract on the property until closing?
It varies.  The Servicer will not work on your file unless all required documents are reported received.  Also this depends on the backlog of your Mortgage Servicer.  In general, a short sale takes 3-4 months although in certain instances it can take as little as 45 days (not likely) and as long as 6 months.

Do you have to be behind or late on your mortgage payments to be approved for a short sale?  No, this is not a requirement.  In fact, to preserve credit, it is better to be up to date.

Is it possible that a Servicer will write off the short fall between the mortgage balance and what the property sold for?  Yes, depending on the tolerances of the Investor (the one who owns your loan), it is possible that the Servicer will write off the short fall with "0 dollars owed" and wll report on the credit report "Paid in Full for less than agreed to". 

The following tax-related questions/answers are provided directly from the IRS website.  See entire IRS explanation here. It is is highly recommended that you consult with a tax professional and/or accountant who is knowledgeable about short sales and foreclosures.

What are the possible tax consequences relating to the short fall between the mortgage balance and what the property sold for? Buyers typically receive at 1099-C for relief of debt, and under certain conditions the tax consequences of a 1099 is forgiveable under the Mortgage Relief Act of 2007. 

What are the provisions of the Mortgage Relief Act of 2007? (Source: IRS provisions) 
If you owe a debt to someone else and they cancel or forgive that debt, the canceled amount may be taxable.  The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief.

This provision applies to debt forgiven in calendar years 2007 through 2012. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately). The exclusion does not apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home’s value or the taxpayer’s financial condition.

What is Cancellation of Debt?
If you borrow money from a commercial lender and the lender later cancels or forgives the debt, you may have to include the cancelled amount in income for tax purposes, depending on the circumstances. The lender is usually required to report the amount of the canceled debt to you and the IRS on a Form 1099-C, Cancellation of Debt.

Is Cancellation of Debt income always taxable?
Not always. There are some exceptions. The most common situations when cancellation of debt income is not taxable involve:

• Qualified principal residence indebtedness: This is the exception created by the Mortgage Debt Relief Act of 2007 and applies to most homeowners.
• Bankruptcy: Debts discharged through bankruptcy are not considered taxable income.
• Insolvency: If you are insolvent when the debt is cancelled, some or all of the cancelled debt may not be taxable to you. You are insolvent when your total debts are more than the fair market value of your total assets.
• Certain farm debts: If you incurred the debt directly in operation of a farm, more than half your income from the prior three years was from farming, and the loan was owed to a person or agency regularly engaged in lending, your cancelled debt is generally not considered taxable income.
• Non-recourse loans: A non-recourse loan is a loan for which the lender’s only remedy in case of default is to repossess the property being financed or used as collateral. That is, the lender cannot pursue you personally in case of default. Forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancellation of debt income. However, it may result in other tax consequences.

What does exclusion of income mean?
Normally, debt that is forgiven or cancelled by a lender must be included as income on your tax return and is taxable. But the Mortgage Forgiveness Debt Relief Act allows you to exclude certain cancelled debt on your principal residence from income. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief.

If the forgiven debt is excluded from income, do I have to report it on my tax return?
Yes. The amount of debt forgiven must be reported on Form 982 and this form must be attached to your tax return.

Does the Mortgage Forgiveness Debt Relief Act apply to all forgiven or cancelled debts?
No. The Act applies only to forgiven or cancelled debt used to buy, build or substantially improve your principal residence, or to refinance debt incurred for those purposes. In addition, the debt must be secured by the home. This is known as qualified principal residence indebtedness. The maximum amount you can treat as qualified principal residence indebtedness is $2 million or $1 million if married filing
separately.

Does the Mortgage Forgiveness Debt Relief Act apply to debt incurred to refinance a home?
Debt used to refinance your home qualifies for this exclusion, but only to the extent that the principal balance of the old mortgage, immediately before the refinancing, would have qualified. For more information, including an example, see Publication 4681.

Can I exclude debt forgiven on my second home, credit card or car loans?
Not under this provision. Only cancelled debt used to buy, build or improve your principal residence or refinance debt incurred for those purposes qualifies for this exclusion. See Publication 4681 for further details.

If part of the forgiven debt doesn't qualify for exclusion from income under this provision, is it possible that it may qualify for exclusion under a different provision?
Yes. The forgiven debt may qualify under the insolvency exclusion. Normally, you are not required to include forgiven debts in income to the extent that you are insolvent.  You are insolvent when your total liabilities exceed your total assets. The forgiven debt may also qualify for exclusion if the debt was discharged in a Title 11 bankruptcy proceeding or if the debt is qualified farm indebtedness or qualified real property business indebtedness. If you believe you qualify for any of these exceptions, see the instructions for Form 982. Publication 4681 discusses each of these exceptions and includes examples.

I lost money on the foreclosure of my home. Can I claim a loss on my tax return?
No.  Losses from the sale or foreclosure of personal property are not deductible. 

If I sold my home at a loss and the remaining loan is forgiven, does this constitute a cancellation of debt?
Yes. To the extent that a loan from a lender is not fully satisfied and a lender cancels the unsatisfied debt, you have cancellation of indebtedness income. If the amount forgiven or canceled is $600 or more, the lender must generally issue Form 1099-C, Cancellation of Debt, showing the amount of debt canceled. However, you may be able to exclude part or all of this income if the debt was qualified principal residence indebtedness, you were insolvent immediately before the discharge, or if the debt was canceled in a title 11 bankruptcy case.  An exclusion is also available for the cancellation of certain nonbusiness debts of a qualified individual as a result of a disaster in a Midwestern disaster area.  See Form 982 for details.

What is a 1099-A? This means that the Lender can still do a deficiency judgment within a time period (meaning the Servicer has not forgiven the debt). This is treated as unsecured debt and the Servicer will most likely have a Recovery Department call the Borrower to settle the amount owed (much like settling a credit card debt through negotiation).

Can you do short sales on second properties?  Yes, these can be approved but consult your tax professional regarding tax consequences regarding second properties.  While the Mortgage Relief Act of 2007 covers exclusions pertaining to primary residences, investment properties and second residences are treated differently under IRS code.

What happens to your credit score if you have a short sale?
A short sale shows your payments as being paid or negotiated and could lower your score as little as 50 points as long as other payments are being made.  A short sale can affect scores for as long as 12-18 months.

Will a short sale affect your credit history? A short sale is not reported on credit history, unlike what happens with a foreclosure.  

Will short sale affect employment (current or future)?  Since a short sale is not reported on a credit report, it will not be a challenge to employment.

How does a short sale affect your ability to get a future mortgage?  Fannie Mae or Freddie Mac (government sponsored) loans allow a mortgage after 2 years.  Currently, for applications for other loans, there are no questions on applications regarding short sales. Please consult a Mortgage professional.