That's one reason I'm not a big fan of mixing personal and rental use - it gets too complicated for tax purposes, and it's too easy to lose your personal residence tax exemption.The way I see it, you have a few options:1) Sell w/ seller finance, and recognize your gains over the term pro rata w/ the proceeds from the sale.2) Move back in for 2 years, then sell as a personal residence?

We have been very successful structuring our investments in the following manner:- Investor returns are equal to the cash flow of the property distributed in accordance to the pro-rata shares invested by the members.  

There is also the issue of non-secured creditors who should receive a pro-rata share of the estate. 

I have posted this elsewhere, but it seems to fit well here too:American Pension Service's Newsletter on UBIT From David HanickI spoke with David a few years back when we were setting up a blind pool fund to see if certain transactions would trigger pro rata UBIT.

DISCLAIMER: I'm not a lawyer, but I imagine this language could be used to justify billing back some pro-rata share of the water bill back to this particular tenant - even with the knowledge that the tenant has never previously been charged back for water since there is a "No Waiver" provision.

You propose a pro rata share of the selling price of the entire property.

I suggest filing for an extension to have this corrected so that you can file properly and avoid being audited.If you file using the Partnership LLC Schedule K-1 IRS Form 1065, you and your partner should show your pro-rata income, credits and deduction here.Check with your state requirements through a CPA just to verify what I said was correct. 

The more sophisticated method is to bill back the water bill on a pro-rata basis according to either the number of tenants in each unit or the size of each unit.

Either he has already paid the taxes for the year and you have to add your pro-rata share on the closing and then you will deduct them on your taxes or he has not paid them yet and you will get a credit to reduce the purchase price by the pro-rata share he should have paid and then you will have an offset on the entire tax bill paid so your deduction will only by your pro-rata share for the year.

Even better is that the water is now being billed back to the tenants on a pro-rata basis and eliminates a huge water bill each month.After it's all said it done the property went from a 4.5% cap to a 6% cap when you factor in the amount of money that went into the rehab.