As a clarification, in California, if the money is used for a business purpose, as is the case with rehab loans, a NMLS endorsement is not required. 

Bob's attorney is saying yes, it was for a commercial purpose, but Charlie isn't GE Capital and Bob isn't the owner of a hundred units, just a small business guy trying to flip a house. 

He smokes weed outside his unit on a weekly basis (currently this is illegal in ontario unless he can prove it is for medical purposes).

Your WA LLC would, as a single member LLC without any special election, be disregarded for tax purposes anyway.

My question is about how to treat the loss for tax purposes.

It doesn't matter how long you hold the property, whether it be more or less, because the purpose of depreciation is to estimate the annual wear and tear on the property. 

Does anyone knows if any kind of insulation that is required for section 8 purposes.

A “security”, for SEC purposes, is an undertaking that pools investor funds with the expectation of profit (and such investors are not all active managers of the undertaking)b.Securities must be registered with the SEC [This a costly and time-consuming up-front process plus onerous ongoing reporting burden – Ed.] per the Securities Act of 1933 or the security may have an exemption from registrationc.Section 4(a)(2) of the Securities Act contains the “private placement” exemptions.

This is why I've yet to pull the trigger on making a real estate investment for the sole purpose of vacation rentals. 

In order for the note #2 interest to be deductible, the proceeds must be used for investment or business purposes.