After the sale, the borrower no longer has any say about the property unless they are in a redemption state and meet the requirements for redemption.These are General Guidelines and by no means are applicable to all jurisdictions and every circumstance.

A good rei tax pro can figure it out to tour specific circumstances. 

The circumstances surrounding it aren't the greatest, as he was essentially screwed by his wife's sister after she agreed to use her credit to get them into a house that they paid down for $400K over 10 years, she didn't pay the down payment, or taxes an insurance, and now she is demanding more than half the $500K equity after saying multiple times in 10 years she wanted nothing in return.

@Joe Gamatoria I can't have 2 FHA loans in my name unless I meet a set of very specific circumstances, which I do not.

The penalty and tax will remain, but there may be other offsetting tax benefits in other areas that will help lower your overall tax bill.Your expenses to fix up the house can either be an immediate expense or a depreciating asset, depending on the facts and circumstances surrounding your "in use" date. 

For the circumstance you describe:I would gather some comps, and set aside a time to talk with them personally.

They are on welfare for life by choice not circumstance. 

What does getting a "post-baccalaureate degree" (cue the marching band playing "Pomp and Circumstance") have to do with anything here? 

Do any of y'all more experienced investors have any recommendations bases on our circumstances.

Sorry, but you're wrong, you make claims based on your opinion and have zero understanding of the actual law just like the guy above who just posted a link to an article that he THOUGHT was proof that email is not proof, thinking it was a court decision, when it wasn't, the article actually stated that the GAO, a federal administrative agency actually erred in their decision and that two federal cases tried in an actual court with similar circumstances resulted in federal judges ruling against the government, siding with the plaintiffs who sued the government.