Additionally, there have been no negative repercussions of this yet so why are you creating a problem out of nothing? 

You just gained $40k in equity, take the $40k and recycle it to buy another property (that's the repeat part of BRRRR method).

Able to get the seller to agreed to knock down another $10g, in addition to the repairs and inspection fees.

Legals mate,Goes into company operating account and not title company.So in a way it isn't a "Deposit".Plus, would never hold onto it and would always refund as we aren't in the biz of "stealing" deposits per se.It's just a sign of good faith that an investor is willing to put their money where their mouth is and the verbiage also specifies this clearly.If they trust us and are going to purchase a turnkey property from us for $80,000 in cash for example, then there should be no hesitance in paying a $5,000 refundable deposit either.Who bulks at this, isn't serious and hasn't done enough research on our market, company and operation so it's a "no fit".Introduced this a while ago as a protection method to not waste time on calls, deal presentation, company resources, etc... only for someone to go MIA and steal all the inside knowledge they gained from us.

This  would allow me to pay down an additional $40,000 of debt, leaving more funds from the cash out refi for rehabbing a non-income-producing garden unit in another building that I have sitting there.

Additionally, I added a new boiler, installed air conditioning mini splits, and refinished the original hardwood flooring throughout the house.

Also, you don't want to lose the tax free gain on sale. 

The added benefit is the equity you have now created in your personal residence that can avoid capital gains taxes if you live there for at least two years. 

In addition to ensuring that the room is built to the proper load bearing capacity as @Mike Reynolds mentioned, you should also keep in mind that you need a second egress point, such as an egress window, for any habitable room especially if it is designed for sleeping purposes.

It's true that our market has become more and more difficult to gain cash flow but not impossible and many strategies to consider.