I'm currently underwater on my home as many people around the country. Due to certain circumstances, I am planning to sell it and pay out of pocket the difference that I owe.
When I checked to see if it was considered a capitol loss under IRS law, it isn't. According to Topic 409:
You have a capital loss if you sell the asset for less than your basis. Losses from the sale of personal-use property, such as your home or car, are not deductible.
It seems like homeowners who didn't go the short sale or foreclosure route are being penalized for "doing the right thing." While people who did do short sales or foreclosure got tax breaks, responsible underwater homeowners don't have any whatsoever. Additionally, you can claim a capitol loss on a rental property. The tax law needs to change