Two Loans, One house, many problems

Hello,

I'm trying to work through a bunch of problem with my home and I was hoping for some advice from knowledgeable people.

Background story:
I bought a house in 2005. This house was flooded the prior Winter due to a burst pipe and the water stagnated for a few days (or even weeks?) We've had surface mold issues occassionally over the past few years, which we always attempted to treat, but it kept coming back. We renovated 2 rooms and found mold in the walls in both, we figured that it had to have still been there from the flood not being properly dried out. (there is surface mold throughout the entire house now, floor through about 3 feet up) We've attempted to get our insurance to help us out, but they claim it was a "preexisting condition" (which we think it was), however, this many years after moving in, we've been told by lawyers that we have very little chance of winning if we go after the previous owner's insurance company or whoever did the repair work. (It would be a "we say, they say" sort of thing).

We originally paid 155,000 for the house, getting a 120,000 loan and a 25,000 loan against the house and paying the remainder ourselves. Of which, we still owe 110,000 and 20,000 on the loans. Our property is now valued at about 115,000 due to the drop in real estate values. We’ve been quoted by a highly-reccommended company that the repair work for repairing the mold would cost us 25,000, of which we’d have to have in-hand. Adding it all up, we simply do not have the money to pay for the repairs and we decided we need to leave the house. Additionally, the house would need another 30,000 in repairs, but those are not imminent. (Like a new roof and siding)

The house is making my entire family sick. We’ve been told by my Pediatrician that our child WILL NOT get any better living in that environment, so we’ve decided we MUST move as soon as possible.

We are "too wealthy" for government aid, but "too poor" to actually help ourselves at this time.

I must add that there is the possibility that the place could be condemned due to this mold issue. (and no, our insurance wouldn’t pay us a thing unless the condemnation comes from a fire). We estimate the value of the property itself to be only 40,000.

That’s the background story, so know I will not be living in that house and instead moving into a renting situation, I’m wondering what’s going to happen with our house, our loans, what legal actions our mortgage company will take against us, and something else I’m dreading… the “loan forgiveness Income” that the IRS may view this as?

We’re not going to pay on either loan any more. We’ve asked our majority lender if they would like to do a Deed-in-lieu-of, but we don’t know if they’ll accept that with their being a junior loan. We don’t know if we’ll be sued by somebody out of all of this. We don’t know if we’ll have such a huge tax debt that we’ll be haunted by this for years to come. What happens if the place is also condemned?

Already spent 5 years of paying tons of money on loans ON-TIME, rennovating 4 rooms in the place and we'll end up with nothing to show for it… then getting penalized even more for something we don’t even feel was our fault… but that’s our sob story I guess.)

Thanks for any thoughts or advice you can give me. I’m ill about the whole thing, scared at what’ll happen, but I have to move for the health of my child, no matter what.