It looks like short sales and principal reductions will continue to work
as intended, at least for one more year. The fiscal cliff bill that Congress
extends the Mortgage Debt Forgiveness Relief Act through the end of 2013. This means that homeowners who have a portion
of their mortgage debt forgiven in a short sale or a loan modification
will not be taxed on the forgiven amount. Without this tax exemption,
the IRS would have started taxing forgiven mortgage debt as income on
January 1, 2013.
This extension will continue to encourage short sales on underwater homes
and will keep the terms of the National Mortgage Settlement (which includes
principal reduction provisions) from doing more harm than good.