In many instances the IRS currently considers loan forgiveness or Debt Cancellation to be income. See the following IRS publication on canceled debts...
Cancellation or forgiveness of a debt by a lender gets reported to the IRS. The IRS considers it INCOME.
A former homeowner may have to pay Income tax on amount the Lender reports as forgiven or cancelled. That income may move the former homeowner up to a higher tax bracket.
There are exceptions to the rule such as insolvency. Insolvency may be complicated and vary on a state to state basis.
I predict this area will cause more people to file a lawsuit against Real Estate Brokers in the next few years than any other area.
After a homeowner loses his house - will he be pleased when he gets a 1099 from the lender for say $50,000 dollars or more. The homeowner will call his his short sale "helper" and say how can this be, I lost money on that house. I never would have let you sell my house or negotiate that short sale if you had told me about this consequence.
And the Realtors says... how could I, I am not allowed to practice law. Or the Realtor says, I did practice law and I counseled you about tax matters and loan forgiveness.
The good news... Congess is considering a bill designed to protect former homeowners from the nasty consequence of loan forgiveness.
If you are currently considering a Pre-Foreclosure remedy or foreclosure. Speak with an attorney who can advise you on the tax consequences and what you can do to avoid them.