I went into a lease extension negotiation meeting with the tenant feeling like a good guy for having cut him significant breaks on late fees and interest and also skipping annual increases for two years.

We've agreed to a contract on the property but have the Inspection still upcoming and can back out (or ask for a reduced sale price) if we find anything out of the ordinary that would greatly increase our rehab budget. 

He said " he would rather pay $2000 a month than sign a lease with such a crazy price hike "So I have a few options , give 60 days notice , move into the bigger house , now have my larger house, extra bathroom and garage for my hot rod and only increase my portion of mortgage $350 as I believe renting the 1/1 at $1300+ will be cake .Or supply 60 days notice and get new tenant at anywhere from 1850 -2150 a month and stay another year in our small 1/1 . 

You don't want to make the mistake of a $6,000 renovation that only increases the rent $60 and will take ten years to recoup the cost.

@Isaac Hebron on your units, add more value, raise rents, increase the property value and you could be sitting on a gold mine!

However its probably appropriate up front to ask.. how do they handle customer communication and how quickly do they respond per their business systems..  

Could I not just increase earnest money deposit from the next buyer buying from me?

The interior and landscaping are dated and could be updated to increase the home's value to the neighborhood median (close to $600k).Here are my ideas:1) move him into an apartment/condo2) buy the house as a purchase option3) renovate the home4) Sell the home5) buy a multifamily property in partnership with the father in law with the all the equity generated from selling his house.

I need to find a funnel for deals so I can increase my chances of finding that first deal. 

Although assuming some increase is a good idea,  I would be shocked if the taxes increased from 1020 to 2040.