If you are considering a short sale of your property, you should be aware that you might receive a 1099-C form for the amount of your lender's losses. The IRS considers this loan forgiveness. If you have other assets such as savings and you are not insolvent, you might end up being responsible to pay ordinary taxes on the amount of the 1099-C.
There are several exceptions stated in the Internal Revenue Code. An example of this is - you do not have to report the income on your tax return if the write off of the debt is intended as a gift, you discharge the debt in bankruptcy, or you were insolvent before the creditor agreed to settle or write off the debt. Congress passed and President Bush approved an act - H.R. 3648, the "Mortgage Forgiveness Debt Relief Act of 2007". This legislation is effective for discharges of indebtedness on or after January 1, 2007 and before January 1, 2010. The Federal Bailout Legislation H.R. 1424, passed on October 2, 2008 extended this relief through December 31, 2012.
You should consult a qualified tax professional to see if these circumstances apply.
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