If this process is finalized by December 31st, 2012 about 1.5 million homeowners in foreclosure or considering a short sale need to understand the different tax implications.

Unfortunately the Mortgage Relief Act is going to expire soon. This act allows up to $2 million of forgiven debt to go untaxed. If you have your mortgage debt forgiven after December 31, 2012, your tax liability could substantially be increased.

In different cases, banks can choose to forgive some or all the outstanding loan balance. Most of the time, forgiven debt is taxable income. If certain requirements are met, those facing foreclosure or a short sale in which the lender agrees to accept less then the full amount owed on the mortgage, could get tax relief from the Mortgage Relief Act.

After this act is expired, many people foreclosing or short selling their home may have significant tax implications, resulting in taxpayers owing more in taxes when they file their next return.

Although foreclosure and debt canceling are two separate processes, if and when canceling debt comes about rests solely with the lender. This decision could take months or even years after the foreclosure occurs.