Short-term rentals (STRs) offer a way around these limitations by being considered active income if you meet certain material participation requirements, such as working more than 500 hours or 100 hours, surpassing anyone else involved.

I won't ever close on another OOS property without walking it first but that involves paying for lots of flights and hotel/rental car costs if flying out there to make an offers but the $1500 to $3000 would be worth the cost to me to save on future headaches. 

I assume there’s no realtor involved or they’d be upside down.

Just bear in mind that trips to Maui involve 'discretionary' funds...A few more things to think about during your due diligence. 1.

Our mortgage was significantly higher than our flood insurance, and I don't know if we qualify to try to apply for FEMA or if there is other assistance, and if so, if we would apply as a business (we file it on our personal taxes as rental income).

Why type of price point are you looking, what anticipated ROI/cash flow, how much time do you want to be involved in, what is your risk threshold, how long do you plan to hold the property, are you looking to invest locally or open to exploring other markets, etc.? 

And treat this as 1/5th space as a rental.Or down the road, would it be better to have the entire property (home & garage/room) rented out to everyone involved and the property become an investment property. 

If I wanted to be more involved I may have considered starting a real estate biz like wholesaling, flipping, property management, etc.So, I would first determine how much time you want to 'invest' along side that $200k. 

Like most things in real estate, a lot depends on the circumstances of the individuals involved and not just the numbers and figures.I hope this helps explain my thoughts, and I apologize for the lack of clarity when I defined "arbitrage".

Quote from @Joe Mills: You are exempt if you meet one of the following requirements:Owner-occupied buildings Properties with four units or fewer that are owned and lived in by the ownerSingle-family homes Homes that are sold or rented without a broker by the owner, as long as the owner doesn't own more than three at onceIf those don't apply, then you must abide by Fair Housing and you must make reasonable accommodations for people with assistance animals.