That $16k is taxable as ordinary income.

The driveway and walkway are crumbling and the patio is sinking.After walking through the home is seems like it will need considerable work to get the home livable and up to code.

Okay looks like we are going to sink.Inspection came back with nothing out of the ordinary except the HVAC.  

Maybe capital gains, maybe ordinary income.....would depend on the "intent" you could show....you built it to sell it in 2 years, or you built it to keep as a rental, then sold.

We're adding a master bedroom, enclosing a patio and adding a mother in law suite.We obviously want to keep costs low and I feel a bit ignorant about the process.  

As stated $1600 is not out of the ordinary to turn over a tenant, but the lack of communication with your PM is a problem. 

Expenses are allowed if they are considered ordinary and necessary.

As Steve Hamilton II pointed out, you cannot actually get a 0% capital gains rate, as you would only get this rate for the difference between your ordinary income and the next higher tax bracket, then pay a higher capital gains tax on that amount, and so on.Some links that answer your question: http://fairmark.com/general-taxation/your-tax-bracket/ https://ttlc.intuit.com/questions/1898605-long-term-capital-gains-added-to-agi There is also $5.25 million lifetime gift tax/estate tax exclusion, but I think this is a new law that only began in 2013, but if something similar existed before that it would be worth investigating.

against our salary (ordinary income).

If you hold as rental or investment property for at least one year and then decide that you want to sell and structure a 1031 Exchange into other properties, you could take advantage of the 1031 Exchange at that point and probably exchange into multiple properties to really enhance your cash flow.You will actually pay ordinary income tax rates and not capital gain tax rates if you rehab and flip, but with a $10K or less gain, I'm not sure that I would even hassle with a 1031 Exchange.