In large skillet over medium heat, cook and crumble sausage, peppers, onions and chiles until sausage is no longer pink; drain. Set aside.
In large mixing bowl, combine warm water, milk, salsa, sour cream and cheese packets from potatoes. Whisk until well combined. Stir in potatoes and sausage.
Transfer to a greased 13x9-inch baking dish. Bake in a preheated 375°F oven 40 minutes. Top with cheese and continue baking 5 minutes until cheese is melted and golden brown.
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