Imagine doing a short sale where the lender forgives the deficiency of $100K. You restart your life again with a clean slate, right? At the end of the year, the lender sends you a 1099 for the INCOME of $100K - taxable income. Sure, you're off the hook for a majority of the loss, but the tax man will hunt you down. The Mortgage Forgivness Act of 2007 is set to expire at the end of 2012. I suspect that quite a few people don't understand exactly how it works, but it's been a great relief for many people in their tough financial times. All people in distressed situations should seek the guidance of tax and/or legal professionals. Here are some resources with more information.