With this current economic market, the value of the real properties have diminished in some areas close to 50%. Owners in an attempt to save their credit are advised to Short Sale their properties. Doing that requires their Lenders approval. One thing they are not usually told about is the fact that upon sale of their house through short sale for less than what they owe, their bank will issue a form called 1099-C. That means that the seller may owe taxes for the amount of the debt that was relieved by the bank.
The Mortgage Debt Relief Act of 2007, which was enacted in 2007, generally allows taxpayers to exclude income from the discharge of debt on their principal residence. The Act applies only to forgiven or canceled debt used to buy, build or substantially improve the principal residence, or to refinance debt incurred for those purposes, and the debt must be secured by the home.
If you receive the 1099-C form make sure to talk with a professional accountant or lawyer familiar with these matters. It is wiser to consult before going through the short sale.