Just to confirm- does your wife have any other W2 job? 

I suspect maybe something like Hagerstown or Cumberland, which yeah are Class D like markets with declining populations, high drug problems, no strong job base which leads to non paying tenants.

The instruction stated it should go on form 4797, and the loss is subject to unallowable loss limit.

They remain distinct on Form 1040 with different tax treatmentOnly capital losses can offset capital gains (except for the $3,000 allowance)So even though material participation makes the loss non-passive, it's still an ordinary loss that cannot offset capital gains from stock sales on the return.The only way capital losses can become ordinary is upon the sale of your property, and that loss could offset your W2 salary.  

Obtaining REP status does not release prior passive losses. 

She's a hustler and has been working hard since her 1st job at 16.

That would mean one should file for an out of state loss.

For example, a person can go to  a 10 —-13 week school for dental assistant… finish the course get a certificate and have an immediate job making somewhere around 43k plus.. yeah I know it’s not a ton of money, but it’s a good base especially for folks that don’t want to go to college.

You said that the coverage of the loss and I assume the cost of legal defense was an "exclusion" to title coverage.  

Quote from @Brad Tooley: Hello, I' m looking to start a career in real estate investing and want to find a job that will teach me a lot about the industry while also paying well so I can start saving for down payments and all the expenses that come with my investments.