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".

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

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

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

If they seller finance, we have the deed, but they cant 1031 because they would need to find a property ASAP which they want to avoid.

The loss may be less than the MtM loss, but whatever you do--avoid selling subto.

I choose Digb specifically to avoid some of the issues you mentioned.

Consider using an FHA loan to secure a 1–4 unit property with just 3.5% down and take advantage of tax benefits by living there for at least two years.

Most on this forum can't even come up with a downpayment, you can't expect them to ride HOI/tax increases, vacanices, etc., with lower leverage and less cash flow on a property.

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!