This should make you feel more comfortable about doing a short sale on your primary home. You will be happy to know that you don't have to pay taxes on the amount that you were forgiven on your home. You will not get a 1099 for the amount that the bank forgave on your morrgage when the house sold. However, they will only forgive a million dollars for a single owner and 2 million dollars for a couple. which should work for most of the population.
If you have an experienced agent, like myself, at the time that the house is sold, you will be given (by your lender) IRS Form 1099-C. This is a cancellation of debt which serves as your proof that you owe nothing (at least on your house) to our fabulous tax collectors. Don't worry if you don't get this form at the close of escrow, as you can still download it from the IRS at www.irs.gov except you download IRS Form 982 instead and attach it to your return for that year.
Although very few banks are doing principal reductions on homes, if you are one of the lucky few you may be exempted, and that reduction will not count as income on your taxes. Maybe they will start doing principal reductions, since President Obama wants to get reelected.
Tax forgiveness on short sales will, at least, last until the next election. He needs those votes. But, who knows what will happen at the beginning of a new term. The expiration of tax forgiveness is 2012.
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