Are there ways for me to keep an ownership position and partner with a developer to get a better income? If yes, then what kind of deal structures would allow me to do so? How do I ascertain the risk/rewards and not leave too much money on the table? What kind of due diligence should one perform if I am to select a developer/partner? Help!

—Opportunity's Knocking on the Family Door

Dear Opportunity's Knocking,

As you clearly recognize, a 1031 exchange is one option to avoid a capital gains tax. However, particularly because this building has been in the family a long time, you should consider options that would allow you to improve the property and keep it in the family.

I suggest you call some of the local developers within your area to check out the following:

1. Will any of them be willing to develop your site on a fee basis? You could build incentives into such a deal by paying them a fee on completion, as well as a share of any increase over your present net income, minus an agreed upon return on any additional debt or capital used to accomplish the upgrade, for a specified number of years into the future. A sharing of future income would incentivize the developer to program and implement upgrades that would maximize the long term revenue likely to be captured.
2. You should have such conversations with office and residential developers to gain estimates of the likely entitlement and construction costs of the remodeling and new construction alternatives. Next, you or someone you trust should estimate the obtainable rents, as well as operating and financing costs for each of the alternatives in order to select between them. But there is also likely to be a tradeoff between forecast net revenue and degree of management headache and risk, both in the short and long run. As you are aware, it's typically difficult to get property rezoned, particularly for residential use (unless it's for affordable housing). And the longer term management challenges of multifamily rentals are far more onerous than rental office space.
3. Because of the above, you may also want to consider structuring the deal to bring the developer in as manager of the property, as well as programmer/builder. This can be achieved in a variety of ways, including provision for an earning buy-out under which you give the developer a share of the property with a provision that permits you to buy it back from him over time. Alternatively, you could just partner up with the developer.

The good news is that there are a lot of ways to accomplishing what you want to achieve, although probably the most important is to select a developer who is competent and with whom you would be comfortable working. You will also want to do the requisite backup checks to confirm the developer's follow through and integrity. Hope the above helps you make the best decision for you and your family.