Long story short: We short sale an investment home and get hit with a 1099-C (a rather large one). After much counseling and calculations, it was determined that my wife (who was on the loan) was insolvent just prior to the Cancellation of Debt. We thought we had cleared this nightmare.

However, our accountant is using the amount of the 1099-C as a basis for price reduction of the home from original purchase and is comparing it to the short sale price. We owe Capital Gains!

Here's the math she used:
$471k purchase price;
less $162k from the 1099-C = $309k.

Home is sold on a short sale for $360K.

Our accountant claims we have a Capital Gain of $51,000. I understand the math, but just can comprehend the concept of owing taxes on something we did not benefit from. It's all on paper, but we made NOTHING on this home from the short sale.

Is her approach correct?

Thanks in advance.