The answer depends on two things.
First, the Mortgage Debt Forgiveness Relief Act which says the debt discharged through short sales is exempt if the debt is discharged, i.e. the short sale closes escrow by December 31, 2012. There are 9 days left for the Congress to decide whether to extend it.
Second, if it is not extended, there is the insolvency exception you may base your exemption on if you can prove that at the time of the discharge your total liability is more than your assets.
Please check your cpa on the insolvency issue to see if you qualify.
If the lender is discharging debt, you might receive a 1099-C, which will give you income unless you meet one of the exceptions mentioned by the previous attorney. I really cannot see them extending the Mortgage Debt Forgiveness Act for another year seeing as how they cannot pass anything right now, but I could be wrong. In that case, you would need to meet the insolvency requirement. You would file a Form 982 with your tax return in the year you receive a 1099-C.
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The prior attorneys are correct: You may receive a 1099 C, but you may be insolvent or able to exclude the discharged debt from your taxable income depending on the law at the time. I doubt that in reality this will effect your choice.
This is not legal advice nor intended to create an attorney-client relationship. The information provided here is informational in nature only. This attorney may not be licensed in the jurisdiction which you have a question about so the answer could be only general in nature. Visit Steve Zelinger's website: http://www.stevenzelinger.com/