Usually the numbers don't work to build in these neighborhoods, unless government tax credits, etc.Do you see the problem with your two statements:"The turnover costs could/will be high"and"How much more damage could they do?"

. - I will ding their credit such that all credit cards and other debt will cost them more.- I will keep their security deposit for funds owed.- I will do my best to garnish future wages until their debt to me is paid in full.This has worked 100% time so far.  

If the property were owner-occupied, would I only receive credit for one rental unit's income, while the non-conforming basement income wouldn't count?

Seems like a pretty fair recommendation to me.

And when you said the management company takes a 550 credit score , all I see in your future are evictions .   

Luckily, my wife and would be in a position to buy their house from them at fair market value, if that is the best option? 

At a high LTV your leverage will be magnified.If your cash flow really is break even (I have my doubts) then with the magnification resulting from leverage, you could produce a fairly good return (ROI from leveraged appreciation, equity pay down, tax benefits).Good luck

Use gap funding (credit lines, partners) for the down payment.

Things in your tax filing need to be really off to do this.Being a REP/active participant and using cost seg to offset a spouses (or your own if that's all you do) W-2 wages is fairly common practice.

Once I sell that I’m gonna convert to a fourplex and do the ADU.going through cash quickly and also using credit cards when possible like to purchase materials.