It's called "phantom income" – money you never received, but still have to pay income tax on. The law is clear: if you owe money and your lender forgives or cancels that debt, with but a few exceptions, that is a taxable event.

Earlier this year, Congress extended protections against such taxation but only for losses which occurred in 2014. If you had a loss last year, talk with a professional to make sure the tax law can protect you.

This aspect of our tax law is important for anyone whose home has been foreclosed or has been sold under a short-sale arrangement, since that is where your debt is technically cancelled. Example: you owed your lender $250,000, and the home was sold for $230,000. Unless you paid your lender the difference, $20,000 of your debt was cancelled.

Do you owe income tax on this money you never saw? If your debt was discharged by a Bankruptcy Court, or if you are insolvent, you are not obligated to pay any tax on this cancelled debt. The IRS defines "insolvency" as "the total of all your liabilities exceeded the FMV (fair market value) of all of your assets immediately before the cancellation". Assets include such items as your car, house (or condominium or cooperative), furniture, life insurance

policies, and even your pension and other retirement accounts.

These were the only two exceptions to the general rule spelled out in the Internal Revenue Code (§61(a)(12). However, as the mortgage meltdown started to cause thousands of homes across the country to be foreclosed upon, Congress acted. The Mortgage Debt Relief Act of 2007 generally allows homeowners to exclude such cancellation or forgiveness of debt on their principal residence. This law was recently updated so as to apply only through the end of 2014.

Up to $2 million ($1 million if married and filing separately) can excluded.. Any amount over that limit is taxable.

How do you know how much has been cancelled or forgiven? If the debt is $600 or more, your lender is required to send you, by February 2 of each year, Form 1099C ("Cancellation of Debt"), which must state the amount of the debt forgiven as well as the fair market value of any property given up through foreclosure or a short sale.

But beware: some lenders -- even if they tell you and the IRS that you debt has been "cancelled" -- still attempt to collect this deficiency, often by turning the matter over to a debt collection company. This is especially true with short sales. If you are involved in such a sale, make sure what the terms and conditions are before you complete the deal.

What qualifies as your "principal residence" -- which the IRS refers to as QPRI (or Qualified Principal Residence Indebtedness)? This is defined by the IRS as "any mortgage you took out to buy, build, or substantially improve your main home." If you refinanced, CPRI is limited to the amount of the old mortgage principal just before the refinancing.

Example from IRS Publication 4681: "In 2011, Steve acquired his main home for $200,000, subject to a mortgage of $175,000. In 2012, he took out a home equity loan for $10,000, secured by his main home, which he used to pay off personal credit cards. In 2013, when the outstanding principal on his mortgage was $170,000, and the outstanding principal on his home equity loan was $9,000, he refinanced the two loans into one loan in the amount of $200,000. The FMV of the home at the time of refinancing was $210,000. He used the additional $21,000 ($200,000 mortgage loan minus $179,000 outstanding principal balances on the mortgage and home equity loan) to cover medical expenses. After refinancing, Steve's qualified principal residence indebtedness is $170,000 because the debt resulting from the refinancing is qualified principal residence indebtedness only to the extent it refinances

debt that had been secured by the main home and was used to buy, build, or substantially improve the main home."

In other words, if Steve sells his house under a short sale for $150,000, he can exclude $20,000 of debt based on his $170,000 QPRI , but has to pay income tax on the remaining $30,000 that was cancelled ($200,000-150,000- 20,000).

Why can't Steve just claim a loss on his next income tax return? Simple answer: losses can only be claimed on investment property; this was Steve's principal residence.

How is all this reported to the IRS? All cancelled or forgiven income -- whether excluded or not -- must be reported on Form 982, which will be attached to your tax return.

What about other cancellations of debt, such your vacation home, a credit card or repossession of your car? Since these do not involve your principal residence, you can only avoid paying the tax if your debt was discharged in Bankruptcy or if you were insolvent immediately before the cancellation.

There is, however, an interesting loophole in the law. If you own more than one home that is in trouble, nothing precludes you from claiming the exclusion for the first home, moving into the second and establishing it as your new main home, and claiming the exclusion. So long as it does not exceed the $2 million statutory cap, and is accomplished by the end of last year (2104), it is acceptable and legal.

We have not seen the end of foreclosures and short sales. But unless Congress acts to further extend the law at least into 2015, many homeowners will be paying tax on money they never saw.

Publication 4681 entitled "Cancelled Debts, Foreclosures, Repossessions, and Abandonments", while somewhat technical, is still very useful.