Ordinarily, the deficiency that remains after a short sale or a foreclosure is treated as income pursuant to IRC §61(a)(12) which states, “[e]xcept as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) […] income from discharge of indebtedness.” That income is reported on Form 1099-C and is taxable unless an exclusion applies. One of these exclusions may be the Mortgage Forgiveness Debt Relief Act. Homeowners who lose their primary residence in foreclosure or through a short sale may not have to report up to $2 million of the cancelled debt as income if the cancelled debt is “qualified principal residence indebtedness.” Qualified principal residence indebtedness is any debt secured by the principal residence that was incurred to buy, build, or substantially improve the same. This exclusion is set to expire on December 31, 2013 unless it is extended as in 2012. This along with other applicable exclusions can be found on IRS Form 982 .