as i consider this thread i must ask for clarification. is the combined negative cash flow the $20k? and is that ARM of yours "NegAm ing"? if so the deal gets more and more suspect ulness you have a VERY long hold horizon. can we hear from a mortgage broker to advise what sort of loan might be available with a fixed payment for 7-10 years...what are todays rates on I/O products and what LTV might they require.
your first task is to figure out what the depreciable part of the land/structure combo is. you can only depreciate the building, not the land. assuming $400k for the bldg, your first year depreciation is about $14.5k ($400k/27.5 years). this may be a case of the property becoming a keeper just because the thing cannot be sold ...you cannot deduct losses on personal residences so converting it to a "rental" may allow the loss to be deducted. you really need an accountant to treat the several possible outcomes of this situation.
i disagree with home ferret that a year will clean this mess up...my take is end of '09 at best. especially in California where data suggests we are just now seeing the impact of the rate resets in the defaults...until now the foreclosures have been common walk aways and more typical defaultors.