Because of the prohibited transaction rules, doing so could be a violation of the rules, or at the very least, would limit your flexibility with the investment and increase the chances of a prohibited transaction occurring after the investment is made.

I'm wondering the best way to handle applications and collection of application fees, as well as selecting the most qualified tenant.

I run my own credit reports with the information provided on the application. 

My current plan once closed is to have the existing tenants go through the application process.

@Susan O.Non-qualified use is the period of time as a rental (not qualifying as your primary residence).Qualified use is the period you lived in it (qualifying as your primary residence)Your scenario would probably shape up into something like this...Daughter rents for  - 3 years (non-qualified use)You live in it for  -      2 years (qualified us)Total time owned -    5 yearsAmount of exemption available for primary residence - 40% (2/5ths) of the gain up to the $250K limit for you.Plus you recapture all depreciation.And don't forget that a property you convert into your primary residence that was the subject of a 1031 exchange has an overall holding requirement of 5 years. 

I found a property manager to list the property which included pictures, listing, showings, tenant application and walk through.

I have had 3 applications. 1 had too much debt. 1 called shortly after applying saying they don't think they want it because it has a window AC unit and not central air.

Charles Kennedy - I have a 7 unit property next to a university that I self manage and a 6 unit property I self manage from 4 hours away.Here’s what you want to do to maximize your revenue, manage yourself, and limit hassles.

Closet space was severely limited, bathroom space was also very limited. 

Twice in 8 years I've had tenants trash the place, so it clearly wasn't the quality of the PM's applicant screening.