We talked shop for a while and he told me that he has been able to get equity for his deals through some sort of life settlement structure using insurance policies that he purchases at a discount from people who are perceived to be terminally ill, aged or some other reason why there is a higher likelihood that the policy could be redeemed for a higher value.  

All lenders are subject to real estate settlement procedures, ALTA, parts of fair credit and collections,  predatory lending laws, tort law, giving notices required under contracts, just because someone acts as an unregulated lender doesn't mean they are a free gun to do whatever. 

He said the house is in pre-foreclosure, and it's sale is the last impediment to settlement of his parent's estate.

They admitted their mistake and offered a settlement of just over $20k.My question - Is that amount considered taxable income?

The custodian also ask for a Mortgage, HUD/Settlement Statement, Proof of Hazard Insurance and Title commitment.

I had to point out to him that the settlement statements would be needed by him too since they are used in the basis calculation.

.§12-4 The Property Manager must take and pass an ethics course, which shall include discussion of this Code, every four years as a condition of continued professional membership.Antitrust ComplianceAs part of a settlement with the Federal Trade Commission (“FTC”), NARPM® agreed to change its Code of Ethics and will not adopt, encourage its members to follow, or enforce any Code of Ethics provision relating to solicitation of property management work that does not comply with the FTC Consent Order.

Do I have any grounds to negotiate a settlement?

If they don't...If the source of funds used to acquire the property was an unsecured loan or a loan secured by an asset other than the subject property (such as a HELOC secured by another property), the settlement statement for the refinance transaction must reflect that all cash-out proceeds be used to pay off or pay down, as applicable, the loan used to purchase the property.Note the word "all." 

@Michael PlaksI understand that the amount of gain eligible for the §121 capital gain exclusion is reduced in proportion to the total period of non-qualified use divided by the total period of ownership.The point I am trying to make is that the total ownership period begins on the actual purchase date and ends on the day before the settlement date of the sale.