You would not have been reimbursed the full $5k.You would have recorded a loss on the new property policy, most likely raising future insurance costs. 

The biggest question mark that faces us right now is that we are intending on using the capital we have raised for the down payment for the house and trying to get some kind of rehab loan that will not only cover the house but also the expenses required to fix up the place.

We're empty nesters (raised 4 children), with retirement a little over 10 years away.

Will you be able to raise rents and attract better tenants (i.e. is it an area where better tenants want to live)?

Lastly, 1. depending on where the property is located, you might be able to raise rents and still be inside the rent cap. 2. if the property currently has debt, most Agency debt have restrictions that survive the LURA and may further impact you ability to take the property out of the affordable housing stock. 3.Are you under and HAP agreement?

You get the risk/reward of making improvements and raising rents, plus the upside of increasing value beyond the sale price. 

The current rents are below market value and I plan on raising rents up to market value to add equity to the property while it is under my lease option period (similar strategy to a master lease option...).

Non accredited to raising money from other non accreditors.Is this possible in California.

If you're studying for your real estate test, there's some great online schools.

Also they can't test the air conditioner at any temp under something like 45* F.