There is considerable confusion about the Mortgage Debt Forgiveness Act. I hear this from potential clients all the time, who hear it primarily from realtors who are doing short sales and telling them “don’t worry about the excess, the Mortgage Debt Forgicemenss Act means you don’t have any exposure”. NOT TRUE. The Mortgage Debt Forgiveness Act does not impact exposure for deficiency, and does not forgive any debt – its impact is only as to the tax consequences IF the creditor forgives any of the debt. Normally, to the extent this debt is forgiven, it is TAXABLE AS INCOME. The Mortgage Debt Forgiveness Act suspends the operation of the Tax Code provisions, as to qualified personal residences, but for a limited time due to sunset at the end of this year. Unless the deadline is extended, once it passes, any principal that is forgiven is again taxable as income, UNLESS the borrower is insolvent or the debt is discharged in bankruptcy or the loan is a non-recourse loan.
See http://www.irs.gov/individuals/article/0,,id=179414,00.html for details.