The "the bank take it back" transaction itself - reportable on 1099-A - http://www.irs.gov/pub/irs-pdf/f1099a.pdf should be treated as disposition of the property at the fair market price.
The capital gain/loss is calculated as (selling price) - (basis - that is mainly purchase price with some adjustments)
The loss on personal property is not deductible. If you will have a gain is taxable,
If you negotiate with the creditor and all or part of the debt is forgiven or the debt would be canceled under bankruptcy protection procedure - you are sent the form 1099-C.
Generally - you took the loan and did not pay it back - that is why regardless how you use the money - that is considered your income.
The amount of debt forgiven is reportable on 1099-C - http://www.irs.gov/pub/irs-pdf/f1099c.pdf - generally is taxable, unless an insolvency exemption apply -- you should file a form 982 - to proof your insolvency - and might exclude all or part of canceled debt from taxable income.
Also - you can elect to exclude the cancellation of such debt from taxable income - but should also reduce the basis of your depreciable real property by the amount excluded.
Reporting procedure is described in the IRS publication 334 - http://www.irs.gov/pub/irs-pdf/p334.pdf - see page 23.
Please be aware that filing the form 982 to make an election is required and that form should be attached to your federal tax return.
Let me know if you need any help.
As your rental property was depreciated for seven years - if you have a gain on the disposition - the depreciation for the time the property was rented should be recaptured - up to the amount of the gain.
Thus residential rental property has a lifetime 27.5 years
so 7 / 27.5 = ~27.5% - that income would be taxable at your regular tax rate.