I would think that the short sale does apply here. This is debt forgiveness that pertains to acquisition debt. You can read a brief synopsis of the law below:
Highlights from Project Vote Smart
The following is Project Vote Smart's highlights for this bill, graciously made available by PVS:- Excludes the debt forgiven on a qualified principal residence from the definition of gross income subject to income tax (Sec. 2). - Reduces the income tax breaks on most gains from the sales of non-primary residences using a formula based on the amount of time that the taxpayer actually lived in the property during the five-year period before the sale (Sec. 5).
Congressional Research Service Summary
The following summary is provided by the Congressional Research Service, which is a nonpartisan government entity that serves Congress and is run by the Library of Congress. The summary is taken from the official website THOMAS.
12/20/2007--Public Law. (This measure has not been amended since it was passed by the Senate on December 14, 2007. The summary of that version is repeated here.) Mortgage Forgiveness Debt Relief Act of 2007 - Amends the Internal Revenue Code to exclude from gross income amounts attributable to a discharge, prior to January 1, 2010, of indebtedness incurred to acquire a principal residence. Limits to $2 million the excludable amount of such indebtedness. Reduces the basis of a principal residence by the amount of discharged indebtedness excluded from gross income. Disallows an exclusion for a discharge of indebtedness on account of services performed for the lender or any other factor not directly related to a decline in the value of the residence or to the financial condition of the taxpayer.
Sets forth rules for determining the allowable amount of the exclusion for taxpayers with nonqualifying indebtedness and taxpayers who are insolvent. Extends through 2010 the tax deduction for mortgage insurance premiums. Sets forth alternative tests for qualifying as a cooperative housing corporation for purposes of the tax deduction for payments to such corporations. Qualifies a corporation if: (1) 80% or more of the total square footage of the corporation's property is used or available for use by its tenant-stockholders for residential purposes, or (2) 90% of the corporation's expenditures are for the acquisition, construction, management, maintenance, or care of its property for the benefit of the tenant-stockholders. Allows members of a qualified volunteer emergency response organization (i.e., an organization that provides firefighting and emergency medical services) an exclusion from gross income for state and local tax benefits and for certain payments for services. Terminates such exclusion after 2010. Allows certain full-time students who are single parents and their children to live in housing units eligible for the low-income housing tax credit provided that their children are not dependents of another individual (other than a parent of such children). Allows a surviving spouse to exclude from gross income up to $500,000 of the gain from the sale or exchange of a principal residence owned jointly with a deceased spouse if the sale or exchange occurs within two years of the death of the spouse and other ownership and use requirements have been met. Increases the penalty for failure to file a partnership tax return and extends from five to 12 the number of months in which such penalty may be imposed. Limits disclosure of tax return information that includes individual taxpayer identify information. Imposes an additional penalty on S corporations for failure to file required tax returns. Amends the Tax Increase Prevention and Reconciliation Act of 2005 to increase the estimated tax payment due in the third quarter of 2012 for corporations with assets of at least $1 billion.
Notice the first few paragraphs, particularly the paragraph beginning with "Public Law". I base my opinion on this reading.
I hope that this helps.