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.

They would get that $500K tax free and the rest of the tax would be deferred in the 1031.A very elegant solution that puts $500K tax free in their hands now. 

For example, instead of tax returns and W2s they will check bank statements and the After Repair Value (ARV) to underwrite the loan.

According to our understanding:1) California does not recognize REP status, but we could claim it on our federal taxes, is this correct ?

To attract investors, offer incentives like high cash flow potential and tax benefits, and structure the deal with clear legal terms and contingencies to minimize risk.Good luck!

But as stated probably not for tax purposes for the seller. 

Mostly because the tax incentives are *insanely* good. 

There's obviously quite a bit of diligence that comes after such as who the key principles are and their credentials/track record (both balance sheet and experience), the underlying real estate and thesis behind the investment & tax prep and audit procedures but as a general rule of thumb if the investor can't get past the first part which is understanding what they are investing in, passive investing is probably not for that individual. 

However, these programs typically qualifies borrowers based on their income, such as tax returns.The DSCR would be a good option considering you and your husband are entrepreneurs and the tax returns don't look good on paper.

could be just like a regular deal, but if you're up for pitching, presenting and educating a seller on the tax and other advantages of seller financing, you just might turn it into a seller finance deal.