I know that when syndication interest is sold the passive losses are essentially forfeited, but I am not sure if the passive losses still being carried over from the 7 year hold can offset the capital gains (or if those are treated separately by the IRS). 

Yes, generally speaking all liens other than government liens (IRS, state liens, etc...) are forfeited.

I would send him a letter stating he has X days to complete all jobs and pass the city inspection or he forfeits all proceeds. 

I am not sure about your state but in Florida, wehave a contract here called “contract to lease” whereby a tenant puts down a deposit and if they don’t come up with the first month rent by the move in date, they forfeit their security deposit.

The original owner died unexpectedly and the family ended up with it.They did a few repairs with the deposit the second potential buyer forfeited.

Are they forfeiting what they put down? 

Would prefer to have them learn a lesson by forfeiting the rest of the deposit but it looks like i will be filing a criminal report and then they can decide if they want to pursue it further, as will I.

In the future, send an email outlining timeframe for paying deposit, method of deposit and conditions for refund of deposit (or terms of forfeiting deposit).

If the closing does not occur on or before the Closing Date then this Agreement is immediately cancelled and considered null and void, all rights under the Purchase Agreement transfer back to the Assignor, and Assignee forfeits their non-refundable earnest funds.

At most, they forfeit the deposit up to one months rent.