If you lived in the home as your primary residence for 2 out of the last 5yrs, you may be able to skate on the tax consequence under the Mortgage Debt Forgiveness Act of 2007.
If this is not the case for you and you are suffering from a financial hardship you CAN still state your case to the IRS to allow you to get protection with the Mortg. Debt Forgiveness Act.
If you end up having to deal with the tax consequence it will be on the negative balance & calculated based on your own tax rate.
I am not a CPA, please ask these questions to & consult with your accountant or tax attorney. these statements are made based on my experiences as a short sale Realtor, accounting & tax law is outside the scope of my knowledge.
Shoot me an email directly if you want to talk about this some more, I don't look back on this same Trulia thread for answers posted after mine.
Realtor Since 1996
Main Street Realtor
Short Sale Expert