They can see this by seeing if you filed a homestead exemption which is typically done in in CA to reduce your property tax basis by 7k to lower your taxes and this shows you lived there and then they go back to see if you switch it to a rental later by checking to see if you have an offsite mailing address.

It sounds like you've experienced the dilemma a lot of us do - that what you do to pay less in taxes (reduce income, accelerate/increase expenses) ends up hurting you when it comes time to apply for a loan.The good news is that if you own your own business and know you want to start usingou bank loans, you can start making yourself look better by increasing your salary, etc.Once you feel more comfortable with RE investing you also definitely might benefit from looking into a Solo 401(k) - but I almost hesitate to mention it because at this point it could just complicate your life and distract you from learning more about RE.

If the sale price is lower than the assessed tax value, apply to get them reduced with the sales data.

Do you see much opportunity to boost rents or reduce utility costs?  

Refi at higher value, reducing cashflow to $100/month, but putting $50K in play for you. 

I am wondering how hard it would be to create a mortgage for this note which in my opinion would reduce the risk .  

I'm a former contractor, specializing in "green" technologies and efficient energy use retrofits.

My reason for considering conventional is: I have the money to put 20% down, the mortgage payment would be lower, which reduces my overall cost of living.

Track all properties income and expenses you are responsible in report form with people you feel comfortable with and understand your goals and all of you might reduce some of your expenses and increase your income.Do not assume anything.  

I haven't done any lease options myself, but in my experience as a realtor, you will greatly reduce your pool of potential buyers.If your property has increased that much in value, another option would be to carry back the loan yourself.