I have Solved this issue.
The issue was the ftp(file transfer protocol) Program I was Using. It is know as fireftp(addon for firefox).
The Program Altered and corrupted image files making the un viewable by any means.
I have been fighting with this problem for awhile now to no resolve. I have search high and low and tried many methods to fix this issue.
I have done 3 os re-installs and many many different versions of xampp were tried.
My problem is as fallows,
All images regardless of format,size,location,lan(or www) DO NOT WORK, are missing or are corrupted.
I have tried host file editing, and the enablesendfile modification to fix this issue with no avail.
I currently have a site running where you can view my problem
When you click view image/background you are presented with 1 of 3 outcomes:
1. your browser opens a new page with direct link info ex: an image at http://www.local.com/image displays as http://www.local.com/image.jpg
2. you are presented with an error stating that the image is corrupt
3. a broken/degraded image
Please help i have tried everything and im about to smash my server!
P>S Also the xampp status pages show images just fine. witch makes me think it is a php issue. but i am not 100% that html is not affected