They will work with the buyer to re-set the loan and terms because when they foreclose and bid the property in for their loan amount which they mostly do around here, they have to recognize the loss as a non performing loan which has a multiplier effect on their lending base.

When your rental produces a loss in excess of income (AGI) you have a passive loss.

Also, do the aggregate losses above any W2 income get carried over to the following year?

If your income is below the $150,000 AGI limit you will be able to use up to $25,000 of the passive losses (if any) to reduce your income and therefore tax. 

To your questions though, my clients have not experienced the dramatic loss of negotiating ability that you have illustrated.

Alternatively you could use Section 179 expensing here as well, but the expensing can't create a loss for the rental and may be carried forward.

BUT this applies to experienced builders who have a strong track record of successful projects without trailing loss history.  

Doing a 203k on a multi can be challenging, depending on tenants so your best bet is to get one vacant, but then you are at a full loss while construction is going on.

Passive Activity Loss RulesIf you are a real estate investor that doesn’t qualify for REPS status (discussed in #5 below), understanding the Passive Activity Loss rules is crucial.

Real estate/passive investments are already preferential when it comes to taxes since they usually show a loss on paper and the income is not subject to SE tax.