I need some advice from someone who has been in this position

1st Mortgage-$363,000 2nd Mortgage- $89,500 SUMMARY • originally purchased as a primary residence in 2004. • refinanced in Aug. 2008 due to a pending personal lawsuit against me (took equity out). • moved to another part of town Oct. 2008. • rented property at a loss for 2 years (renters pre-paid 6-12 m advance) • renters moved out 12/31/07 • arm adjusted • we are upside down and just want to get rid of the home. • have not made a payment to either lender since Dec. 1, 2007. • first lender has filed foreclosure and sale is set for June 25, 2008. • home has been on the market for >90 days and the price lowered twice to market value, with no movement. • recently received a short sale offer of $325,000 that is being evaluated by the 1st mortgage holder. This will not cover the first and the second is out completely I have questions whether or not a short sale is our best option? Questions 1. What is best course of action to minimize credit damage, summary judgment and/or IRS 1099 with both the 1st and 2nd (Deed in Lieu, Short Sale or Foreclose) • My biggest concern is the 2nd mortgage ---consequences • I consulted with an attorney today who said deed in lieu>>short Sale>>foreclosure >> bankruptcy. He also mentioned a new law Jan. 1, 2008 relating to no 1099 for foreclosure in 2007, 2008, 2009. He stated the law would not cover the difference between my refinance and original purchase price. 2. Should I be discussing options with the 2nd or do I let the 1st deal with them? We are basically insolvent and attempting everything possible to avoid a bankruptcy.