I'm in the middle of creating a business plan and researching funding options to replace the potential investor so I don't loose my momentum. 

Include Proof of Funds.

If, on the other hand, they did a cash out refi to take it to 80% LTV, aka borrowed 800k against it, then sold it, wouldn't they only owe cap gains on the 200k remainder?

There are commercial loan products available to first time investors although they are normally subject to a slight LTV reduction given the lack of experience. 

@Alyse Oz I don’t have much experience with forming LLCs for rental properties but for use in a startup or business most incorporate in Delaware because they have a separate court for business entities and they allow for easy transfer of venture ownership to allow startups receive funding from VCs.

The reason I ask is that if you sold the units you could potential afford the initial costs if you can obtain 80% LTV (but it would be tight).Sell units: $330K value - $30K (cost to sell including agent and prep) = $300K

If I invest in a note fund, are the periodic payments first considered taxable interest or are they first considered return of capital?

Low LTV, 60 - 70%.

Earnest, it really depends.How much do you have in time or funds to advertise.

The house was purchased with Cash using HELOC funds from our primary residence.