It looked like I would be buying $40k in equity at closing, so we couldn't go wrong! 

I could be wrong however.

I would assume getiing approved together would limit our future options.. am I wrong?

If things go wrong it's going to be a hassle but you should break even. 

We have to make sure we get an inspection, find out what's wrong with the property, see if it's economically feasible to rehab the property, ensure we are compliant with all local/state rules regarding REO property, register the property if applicable, ensure health and safety issues are addresssed (Toxic DDT Landfill?)

Nothing worse than your guts telling you something's wrong, then you pull the trigger anyway.  

If I am wrong about that and someone has one I would love to buy it!

I don't want to make the wrong decision on picking a house.

I know things will go wrong with the house.

I'm not saying you're wrong (this is clearly your business, so I imagine you're right), but I'm trying to understand how this risk comes about legally for a buyer/seller so I can better understand other insurance risks I might face...