Many are selling to avoid this which is creating a small pocket of increased DOM with decreased values... and buyers are willing to eat 40-60% of the fee as they can put it on their tax bill for 10 years. 

Such documentation may include:  Closing statement when the property was purchased showing the purchase price;  Documentation showing the depreciation allowed or allowable, if any;  Documentation for any capital improvements and other increases in basis; and  Documentation showing decreases to basis, including any deferred gain from any prior sale(s).

The bank could finance it at $125k because the apprasial came back great, but its this legal technicality that is costing me $8k ($10k less the $2k decrease in the 20% down payment).I already tried getting A and B to change the sale contract to $125k including fees, but A didn't want to change anything. 

I would ultimately like to refi, get the money I have put into it back, and use that money decrease my overall debt to income.

But because we don’t depend on our real estate investing income for survival, if there is a market correction that causes a decrease in home values more than 20% and rents to drop 15-20% also, then our cash flow may temporarily go down to zero.

Your issue is that you can't get a heloc.But I gotta tell you - to decrease legal density just to get a finance instrument seems incredibly short sighted. 

Is there a rental cap already in place and are they trying to decrease it? 

I had to drop rates to get empty units occupied because there was a lot on the market, but never decreased rent on current residents.  

This will decrease my cashflow but increase my cash on cash return.

Wait until the market volatility decreases and things shake out?