At first glance, the “short sale” of a home looks like a win-win solution. The homeowner who owes more than the property is worth gets a break on the difference when the property is sold, and the lender recovers more than it would by pushing ahead with a foreclosure.

The Obama administration, in an effort to tweak its Making Home Affordable program, has announced provisions (PDF) to encourage short sales with financial incentives for mortgage servicing companies and homeowners.

But troubled homeowners should check all alternatives before resorting to a short sale, as there can be ugly tax and credit-rating consequences.

The concept is simple. Let’s say you bought a house a few years ago for $300,000 and still owe $285,000. Now the property is worth only $240,000 and, because of a job loss or other setback, you’ve fallen behind in payments.

In a foreclosure, the lender takes over the property and sells it to recover as much as possible. With a short sale, the lender agrees to accept less than the full balance on the debt, and the owner contracts with a real estate agent to sell the property.

Either way, the homeowner can take a huge credit-rating hit that will make it difficult to borrow in the future, though most experts say a homeowner can generally qualify for a new mortgage sooner after a short sale than after a foreclosure.

In some cases, the borrower must pay federal income tax on portion on the debt forgiven in a foreclosure or short sale, though there are exceptions for a primary residence.

According to the IRS explanation, the forgiven debt is tax-free if it had been used to “buy, build or substantially improve the taxpayer's principal residence” and was secured by the residence.

“Debt used to refinance qualifying debt is also eligible for the exclusion,” the IRS says, “but only up to the amount of the old mortgage principal, just before the refinancing.”

In other words, if you refinanced with a new loan bigger than the old one, using the extra cash for a vacation, the extra amount is considered taxable income if it’s forgiven.

It’s a terribly complex matter, and the homeowner should consult a tax expert before going ahead. The IRS has publications that offer more details and examples.

Modifications to the Making Home Affordable program will pay loan servicers $1,000, and homeowners $1,500, as incentives for short sales. The home must be offered for sale at its current fair market value, determined by the servicing company.

Look for details on the Making Home Affordable site and begin the short sale process by talking to your servicer, the company to which you send your monthly payments.

Short sales are a last resort, only slightly preferable to foreclosure. Before making this move, consider the other options in the Making Home Affordable program.

One helps homeowners modify terms of their existing mortgages to reduce monthly payments to no more than 31 percent of income.

The other helps owners refinance loans owned or guaranteed by Fannie Mae (Stock Quote:FNM) or Freddie Mac (Stock Quote: FRE), the government mortgage companies.

And don’t overlook the regular refinancing process. The standard 30-year fixed-rate mortgage now averages just over 5 percent, according to the BankingMyWay.com survey. Use the search tool to find the lowest rate you can, then put the numbers into the Refinance Interest Savings calculator to see if that would make your payments affordable.

A foreclosure or short sale can be so damaging to your credit rating that it may well be better to take in a roommate, beg a relative for help or sell a car or other asset to raise money.

—For more ways to save, spend, invest and borrow, visit MainStreet.com.