@Ashish Acharya and @Dmitriy Fomichenko  thanks for the responses.Currently, we are using the schedule C plan to fund the solo 401k, however, income on Schedule C gets taxed as ordinary income, which is a huge hit.Follow my thought process here for a moment:I form a separate LLC taxed as an S-Corp, lets call it XYZ. 

Private lending is passive but in terms of taxes "ordinary income" and you cannot cancel out with passive losses that you get when you are an equity holder of real estate. 

To ensure you can apply the tax deductions against ordinary/active income, you have to materially participate in the STR business.

@Eric AndrekopoulosHe could also sell them and not have to worry about if the borrower is paying or not - put the funds in a deferred sales trust and invest it in something less risky (not levered at 90% which is probably what it would be seller financed) and not pay ordinary income but have it taxed at qualified dividend.There is a reason why 99% of loans are originated by banks and not by sellers.

We updated the kitchen, added a 3rd bedroom and added the back screened patio to the house.

@Kim LeJeuneI have to assume that it was a rental house, as opposed to your personal residence or a flip.Each monthly payment has 3 components: interest - taxable as ordinary incomereturn of your principal - not taxablecapital gain - taxable at various ratesYour down payment has components #2 and #3.Interest should come from an amortization table. 

Also had a new front patio built a few years ago along with all new electricity a few years back.

So, the profits (generically, sales price minus cost basis or prucahse price) are taxed as ordinary income also subject to self employment tax.Sale of an investment property, i.e. one that was rented, is considered capital gains.It is your intent of the property that signifies which taxation applies. 

But you can still treat it as resulting in Ordinary Income even though it is reported on Schedule E, which lets you properly report in accordance with the tax results it seems you are shooting for under the tax return loophole.If your CPA is looking at switching it between schedules to get that tax result...it sounds like they don't understand the reporting position fully and/or they just don't know how to use their own software to address it.In summary, based on what you are describing for the situation, it should go on Schedule E, with what sounds like the resulting refund of $17k.

I know people pay over the appraisal in competitive markets but my situation is not ordinary.