Usually when you owe a debt to someone, and it is "forgiven," i.e., you no longer have to pay back the debt, the amount of money forgiven can be taxable.
In 2007 a law was passed to assist those who lost their homes through foreclosure or a short sale. The bank had to send a 1099 to the homeowner, but from 2007 through 2012, if you meet the IRS criteria, you will not have to pay any tax on the amount of the loan forgiven.
You can get more information on the IRS.gov site at http://www.irs.gov/individuals/article/0,,id=179414,00.html.
If you are considering selling your home through a short sale, the time to act is now. I wouldn't count on Congress extending the law to cover beyond 2012. Since it is a longer process to sell a home through a short sale, getting approval from a lender to enter their short-sale program as soon as possible will help you meet the law's time table.
For more information or to see if you will qualify for a short sale, contact a knowledgeable real estate agent. You can also get more information and examples in IRS Publication 4681.
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