At the final hour Congress finally reached an agreement avoiding the Financial Cliff, at least temporarily. Included in that deal is the extension of the Mortgage Debt Forgiveness Act through the year 2013.
This means, as it has since the inception of the Act, that homeowners who short sale their their home and sell it for less than what they owe, or obtain a loan modification, will not be responsible for taxes of the forgiven amount, with some exceptions.
Also, at this time, the previous California exemption lapsed at the end of 2012, so forgiven mortgage debt is considered taxable state income for the time being. Upon passage of SB 30, the measure will be effective retroactive to Jan. 1, 2013.
Below are valuable links to understand in detail the Mortgage Debt Forgiveness Act: