They paid tax on $450K but sheltered the other $340K of profit, eliminated their mortgage and ended up with passive income for the rest of their lives.Option 2 would be To sell for $850k and generate $550K in cash. 

I will state first see an attorney who is experienced in putting together entities.In the operating agreement is where you are going to want to put the accountablity issues front and center.

Where could that money be used to generate that much value?

This is another income stream but it's useless if you have a small operation.

Your Net Operating Income , theoretically, should be $158,760.  

@Matthew DrouinThat is a great position to be in.Now with regards to the refinancing options and how much you should take out, I'd say it depends on what your plans are.If you are planning on holding onto to that rental for the foreseeable future, you should stress test that property to figure out how much minimum income it needs to generate each month to meet your mortgage payments.That monthly would dictate how much you can conservatively take out after refinancing (and providing that you lender is OK with that too) without exposing yourself.Now if you have other deals that you want to pursue and you need as much cash as you can lay your hands on, you should take out as much as your lender would allow you to.Personally, I'd go for the option 1, especially if you have the  ambition is build a sound rental portfolio.

If she is operating the S Corp in CA she is going to most likely be subject to income tax in CA on that income despite her residency with the military.

I would be hesitant to give the generated information away for free, especially to another system that is fraught with accuracy issues. 

You should not be operating a business without first knowing the laws that govern your business.

Find a turn key in Arizona that will generate lots of cash.