I know I will have to pay incomes taxes as apart of this conversion, but I've been doing some reading and can't seem to understand if I will also be hit with additional taxes as a result of something called "pro-rata rule".

Primary is your primary.the duplex is a partnership nothing wrong with you guys simply taking title as Tenants in common as to a pro rata share ownership.. you each have to qualify and sign the loan docs...

One could credit the remaining folks for the deposit on file and return just the leaving tenant pro rata, but then you need a small check from the remaining tenants anyway to get the full deposit, and you never know how they have allocated or paid the deposit (or even if they are on good terms), and you rely on the kindness of strangers to return it to the leaving guy (so he does not ask you for it later).Either way, make sure it is crystal clear and communicated (I communicate it multiple times) to ensure a smooth transition and prevent problems; that may be key, get the fuzziness out and make sure no feathers are ruffled.

Each year your k-1 will show the allocated income on a pro rata basis.

Capital gain is a little more complicated, with a pro rata share of principle received being taxed.

. :) Hmm I may be missing something here.....Each partner/investors portion of the profit would be pro rata, that's why your ROI would be the same. 

So, I would suggest a pro rata refund to the tenant/tenant's estate.One electrical socket not working is not worth fighting over with the tenant. 

Please note any unpaid preferred return will be accrued:Senior debtholderRepayment of capital and any accrued returns to meet the 9.0% preferred returnAt sale investors will receive their pro-rata share of 25.0% of the remaining profits

If the lease is terminated, the tenant is entitled only to a pro rata refund of rent from the date the tenant moves out and to a refund of any security deposit otherwise required by law.

No modification is needed to the operating agreement and as long as you are calling for capital pro-rata from the investors their ownership percentages stay the same relative to one another.Having explained all that, if it were me I wouldn't do it.