Found a workaround.
If you set the umask to 022 you will be able to build linux and copy to mcpc and boot without being prompted for a root password.
The ubuntu box I was using as a buildPC had a default umask of 002. This caused the Linux build to give the /root /root/.ssh wrong permissions.
So to solve the problem make sure you have umask 022 in your /etc/profile.
I also did a fresh install of the build repository. I believe if you do not have the umask set correctly at this point, this is where the problem starts.
Checking the sccLinux/target_skeleton files, showed improper permissions for ssh access when umask 0002 was used.
Thanks to Jan-Arne Sobania for the step by step procedure using virtual serial ports and minicom to help solve this problem. A very useful diagnosing feature.
One workaround is:
Make sure you have a umask of 022 before downloading repository.
I can confirm that this works perfectly. I tried both ways and you are correct the umask has to be set before downloading repository otherwise problem persists.