Example: an investor experiences a $1MM gain from the sale of an investment property and cannot find a suitable replacement property for a 1031 exchange, therefore is staring at a $400k tax bill. 

But, by buying first you can often mitigate the ticking time bomb of having to identify a replacement property within 45 days.

So, I set a goal for myself to be able to quit my job and have passive income enough to replace it within 5 years.Through the long hours of learning, networking etc the motivation and attraction of "in 5 years I don't have to work....at all" very much lost its luster. 

Basically everything needed replaced except for windows and exterior siding.

Hi Whitney,Talk to an attorney local to the property.You might be able to get a financial judgement (trebled).Step one might be to get three bids on (comparable) replacement systems.American Standard, Bryant, Carrier, Lennox and Trane are names of some furance and A/C (HVAC) manufactures.And realize a new furnace A/C (HVAC) might force you to change the thermostats too (or not).Trying to figure out costs on this yourself (with any resprayed insulation up there) might be pretty tough, (plus you have to buy whatever new refrigerant is required in your area--and the new stuff can be very very expensive).You might be able to pick the brand you like best, or the one fastest installed vs the cheapest...ask an attorney.Also, in a financial judgement, you have to collect...lien their wages or bank accounts (to the extent you are allowed to do so by THEIR Locality).

There is 0% chance that 5 months of "no filter replacement" will, in any universe, lead to major repairs to the HVAC system. 

A picture is attached of the current / proposed layout (I'm not artist)My predicament is that I want to maximize my rent but I'm not sure if it will justify the addition of a wall with a door, the removal of a current door and the replacement of that door with some wall, the enlarging of window to make it meet egress standards (not positive on this one but I think I have to do this), and the removal of a closet to make a section for a door.

You will want to have cash reserves or access to cash in the event you have a large unexpected expense come up, such as a roof replacement, HVAC, etc. 

and of course you can use your proceeds to purchase multiple properties as replacements if you want to expand.If your planning to keep investing then 1031 lets you use all of your equity. 

For my underwriting I use a fixed percentage for replacement & repair reserves as well as vacancy / credit losses so this helps me to envision what the property will do in the event of a downturn.