Here Is Interesting Info From RISMedia.com

Prior to December of 2007, if a homeowner lost his or her house due to a bank foreclosure, and the bank forgave any difference between the price it was sold for and what was owed, the homeowner would owe aditional income tax on that portion.  For example, if the homeowner owed $300,000 on the mortgage, and the foreclosure sale brought $200,000, the bank would forgive $100,000.  However, the homeowner would owe income tax on the $100,000 forgiven by the bank.

Presently, and because of the economic stress existing nationwide, last December Congress eliminated the income tax due on the forgiven portion of the foreclosure sale described above.  However, this only applies to the tax years of 2007, 2008, and 2009.  The old rule would be in effect in the tax year 2010 and beyond.  Eligibility requirements are: it must be the homeowners principal residence; not vacation, investment or other properties.  The ceiling on forgiven debt is $2,000,000.

In regard to home equity loans, if part of the forgiven debt was a home equity loan and was used for purposes other than to build, buy or make big improvements, that portion is still taxable.  Home equity loans used for vacations are taxable.

Short sales happen when a borrower falls behind in his or her mortgage payments and lender approves the sale of the property for less than what is owed on the mortgage.  All proceeds must be turned over to the lender or bank.  The taxable income includes: the portion of the mortgage the bank forgave, any commission or other selling costs if this debt is cancelled.  However, Congress has provided tax relief for the years 2007, 2008, and 2009.  A short sale is not automatic, the bank has to weigh its cost against the foreclosure cost.

If the bank forgives a percentage of debt, say, 25%, of an outstanding homeowner, this is also taxable except for the years 2007, 2008 and 2009.  Compliments of the U. S. Congress.

If the homeowner takes advantage of the debt cancellation by the lender, the homeowner is required,
when the property sells, to reduce the basis (original price of the home) equal to the amount forgiven.  A homeowner can now receive a $250,000 (single) and $500,000 (married) capital gain exclusion on the sale of their primary residence.  Here is an example to clarify the concept based on a purchase price of $300,000 with a married couple selling the property:

Home sells for $750,000
Less Original Basis* ($200,000)
Less Capital Gain Exclusion ($500,000)
Gain on Sale $50,000
Capital Gains Tax at 15%= $7500 (Owed by Owner)

*This is the original basis or price of home $300,000, less the $100,000 debt cancellation by the lender.

Consult your tax accountant or attorney for any complicated situations not as clear cut as above.