The general IRS rule is that any forgiveness of debt will be taxable. In response to the housing disaster of the mid-2000’s, the Act was passed by Congress in 2007 to give relief to taxpayers who had debt forgiveness as the result of either a foreclosure or a short sale. The Act was subsequently extended until December 31, 2013.
A bill to extend the Act for another two years to December 31, 2015, has been in the Senate Finance Committee since June 19, 2013. GovTrack.us gives this bill a 1% chance of getting out of committee and a zero percent chance of being enacted.
Therefore, effective January 1, 2014, the Act will expire and will no longer give any relief to taxpayers who have debt forgiveness resulting from foreclosures and short sales. Opposition to the bill has been based on the need to eliminate tax breaks to reduce the deficit and on refusing to reward individuals who knowingly took out high-risk loans.
Note: Because Arizona is a non-recourse state for purchase money loans, and another general IRS rule is that forgiveness of non-recourse debt is not taxable income, there has been some question whether the Act applied to taxpayers in Arizona with debt forgiveness of purchase money loans.