My client sold an investment property in 2004, he deferred his gain (including depreciation recapture) of 400g into an LLC with other investors. He received a K1 for years with net rental real estate income.  Long story short, in 2014 it was determined that the LLC was part of a Ponzi Scheme. To save the property, the investors contributed enough money to form a new LLC, pay off the property, and continue with rental income again.

IN 2022 it all ends, the real estate is sold, and my client winds up with nothing except 100g of taxable income to close out his capital account to zero. 

His argument states he is out of his original 2004 deferred gain of 400g and should be able to write that off either thru safe harbor Ponzi Scheme rules or at least a Long term capital loss. 

My argument is that as far as the 400g goes from the original 1031 exchange, he never paid tax nor recaptured depreciation, so there is nothing to write off.  Does that make sense?