l have already tried a short sale (no luck), and l am now trying to get approved for a Deed in Lieu.l am in default of making payments for 4 months already.

My question is, How will a Deed in Lieu affect me tax wise in California, versus going into foreclosure? Should l even try the Deed in Lieu, or should l just go into foreclosure?

You will have to pay taxes on the portion of the loan that is forgiven either way. Bankruptcy is the only way to get around that. The deed in lieu greatly benefits the lender, saving them the time and cost of a formal foreclosure. So unless you have negotiated some type of benefit for yourself, such as the bank not coming after you for any additional money due or not reporting your deficiency to the credit bureau, then l am not sure why you would voluntarily sign the house over.

It should not if you negotiate with the bank that they will allow the deed in lieu to proceed and they will forgive the remaining debt. If you have any other assets, the bank may require you to surrender some of those (pay them some cash) to make it happen. But, at the very worst, you might get 10-99'ed for the difference in what you owe on the property and what they can get for it on the open market. Then it is taxed like ordinary income.

l believe that would fall under the Mortgage Forgiveness Act that President Bush signed into law saying that you are forgiven the difference in income if you lost/gave up your house in 2008-2010. It is to keep those who are already in financial trouble from feeling it even more with a $18,000 tax bill. Good luck!