Now, having the gain on the sale you can split that into two taxable amounts. 

Short term ordinary taxable income if there is a gain?

The net result was no taxable gain to the feds or CA.

While technically the interest portion of your debt service could be included as an operating cost (at least for taxable income purposes), in practice all debt service is taken below the line (i.e. it is deducted from NOI, not before NOI).How you finance a business does not change the net operating income produced by the business, but it does change the available cash flow before taxes (CFBT).

By structuring a deal to avoid taxes on cash flow even though the intent of the deal was to generate rent that is taxable.

I read about the ramifications of short sale on the seller such as sale price is considered taxable and some damage to credit.  

This is my passive, reliable retirement plan.My active, taxable investments are all in hard real estate, notes, and some other active small business stuff.

The transaction just gets reported as a taxable transaction and you would only be out the 1031 Exchange fee of $795.00.

I would add that any gift over $12,000 is taxable. 

For owner-occupied homes – including up to five acres of surrounding land – the assessed (or taxable) value is 4% of fair market value, and no school district taxes may be added to the base millage rate.