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A loss on a personal residence is not deductible.

Correct. But irrelevant to Donna. The property was a rental property, not her residence. And even if it had been a personal residence, it's still irrelevant, as the loss was on a secured loan, not on the residence.

In this case, the loss is in the value of the loan. The loan was "settled" with property that had lost value. Is the loss a deductible loss?

There will be no loss on the repossession. Any loss will end up affecting the basis of the repossessed property. There is the possibility of a gain on the repossession. (Probably not in Donna's case, but in general a gain on repossession is immediately taxable.)

Any loss would be recognized when the repossessed property is sold.

Ultimately, you follow the actual dollars. Beginning with the purchase of the property, dollars in minus dollars out gives you the gain or loss over the entire transaction. Some will be rental income or loss, some will be capital gain or loss, and some will be interest income. But it will all work out in the end. (That's the basis of my earlier statement that I knew the answer, I just had to be sure I got there correctly.)


PS - In case anyone is actually trying to research this issue, the buzzword for your research is "repossess" not "foreclose". The literature generally refers to this as repossession of property, as it applies equally to loans secured by real estate and personal property.
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