How would this be accounted for for general accounting and taxes?  

Also, I believe the tax benefits are horrible compared to the states, but I'm not too sure.

There may be something called a "Due On Sale" clause.Check and see if all tax parcels are included in one mortgage or if they have separate mortgages.You have to have him spell out what he considers to be a "partial seller financing".

How do we minimize taxes on the profit we're making on this first home? 

Taxes : Taxes have been a brewing crisis nationwide for sometime, Chicago is another prime example of a major municipality struggling under high debt load.

We're right next to CA but get the benefits of no state income tax, 4th lowest property taxes, much more friendly landlord/tenant laws, no serious weather, proximity to Lake Tahoe, stable job growth/population growth, etc. 

You can always use a software like Turbo-Tax and follow the prompts.

You are looking at the rent of $2,000 and mortgage (Loan, Insurance, and Taxes) of $18000 and thinking you have $200 cash-flow.

At the same time, someone else reduces your debt, and you get to use the tax code to improve your tax situation legally.  

It's a balance of cashflow and wealth accumulation.One of the goals is to have tenants pay as much of your cost-of-ownership as possible (loans, taxes, insurance, etc.)In high-cost areas, any Class A or B property you buy will usually negative cashflow for the first 3-5 years, until rents rise enough to cover the negative cashflow + rising taxes & insurance.Investing OOS increases your risks because you may not know the market and you can't check on everything/everyone all the time.If you move forward with your buddies, HIGHLY recommend creating a solid Partnership Agreement!