Consider private money lending and/or note investing for a passive income source?

When looking for a DSCR lender for your short-term rental, ask how they can underwrite short-term rental income.

All or some expenses run through the PM and offset the income?

It depends on your income / DTI and also what kind of loan you are going for.

If you are looking at a hard money loan, most will only care about the equity in the deal, and your experience in the last 36 months If you are looking for conventional, full doc financing, they won't care about your experience, but will look into your personal income, credit and assets. 

My understanding is comparison sales approach or income approach.Comp Sales approach is getting comps from area and then carving carving 40% +/- off that price. 

I cannot answer if taxes would be more or less if he sells outright, what I can say is he will pay california taxes on the interest income of the loan.

Nor is needing income at all! 

Lots of information about insurance coverage for lenders within the book I co-authored - Lend to Live: Earn Hassle-Free Passive Income in Real Estate with Private Money Lending published by BiggerPockets.

Buy and hold rental income is generally considered a passive investment income unless you are a real estate professional.