The payment which was never received and never included into taxable income may not be deducted.
The actual expenses which the landlord had while the property was available for rent but was vacant - are deducted as rental expenses on the schedule E.
I an not sure why you mentioned "exceeds 7.5% of their AGI"... please clarify.
You are correct - for medical expenses deduction - such expenses should be above 7.5% of the AGI - that is a specific rule for medical expenses - but that generally should be actual out-of-pocket expenses.
Investment losses - should be classified - for instance - if an investment property is sold for less than it was paid - it would be a capital loss. Such capital loss may be full offset other capital gains, but if the person has NET capital loss - only up to $3000 may be used to offset other income in the current year - while the rest should be carried over to the next year. There is no 5 years limit - unused part of capital losses may be carried over till the person dies.
Rental losses are also limited because that is considered a passive activity - the maximum of $25,000 may be used per year until fully used. If the person sells the rental property - the disallowed amount may be deducted.
Please see more details here - http://www.irs.gov/taxtopics/tc414.html
$25,000 for single individuals and married individuals filing a joint return for the tax year,
$12,500 for married individuals who file separate returns for the tax year and lived apart from their spouses at all times during the tax year, and
$25,000 for a qualifying estate reduced by the special allowance for which the surviving spouse qualified.
If your modified adjusted gross income is more than $100,000 (more than $50,000 if married filing separately), your special allowance is limited to 50% of the difference between $150,000 ($75,000 if married filing separately) and your modified adjusted gross income.
Generally, if your modified adjusted gross income is $150,000 or more ($75,000 or more if you are married filing separately), there is no special allowance.
To determine a loss - qualified rental expenses might be deducted. The income which was never received in not a qualified deductible expense.
The client may deduct the depreciation of the rental property, taxes, mortgage interest, repair and utilities expenses, tax preparation fees, insurance, etc