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. 

http://www.realtor.org/government_affairs/mortgage_debt_cancellation

http://www.irs.gov/individuals/article/0,,id=179414,00.html