Also, when the balloon is due in 7 years, how does it work from his standpoint when it comes to capital gains taxes?

He was telling me about one of the new laws that was enacted this year that in order to avoid capital gains tax when selling a “personal residence” you NOW have to have lived in the property for 8 years.

If it's any consolation, the benefits of expensing vs depreciating are only meaningful to those whose loss real estate tax write-offs aren't restricted by the passive loss limitations.

Your personal tax situation does play a role here as these are passive losses and there might be limitations on using passive losses to offset other income, which means that the loss on your K-1 might not be the amount of your deduction.

A boring, passive investment that simply delivers consistently.  

Of course the real opportunity is to improve on that NOI that I will be inheriting from the current seller.I'm doing a 1031 exchange (thanks for all the education @Dave Foster) which should also help me save on the capital gains taxes. 

I don't see any advantage to be gained by your plan.   

If you are looking for passive income then again with your current credit score and a year of seasoning I would hope your score at least maintains above 640 which is usually the minimum for a lender to accept for a mortgage. 

My partner and I started off by forming an LLC but quickly learned that we should probably have a passive and an active income LLC. 

And then using what's left to payoff probably relatively low interest loan that you have on your rental and loosing interest write off deduction doesn't sound like a wise financial move...Why don't you consider setting up a self-directed IRA, moving your Vanguard IRA in there and then invest passively in trust deeds (or some other alternative assets).