Looks like we may be able to make it work using non-QM based on bank deposits.

Handle the deposit like you would at the end of any lease and wish them well. 

Is there any special consideration for taking the security deposit from current manager?

This is advanced rent and is treated similar to a security deposit.

Tenant has late fees dating for over a year and now is pursuing the deposit.  

I have 1 month deposit so it will cover that.

It serves to create a defined contract to point to if there are questions, you learn how the leases function, it's easier to collect deposits, if you sell your house to another investor you can show it's been rented out. 

Through a lot of documentation, I also called out the title company for never providing me a earnest money receipted check or wire transfer - I simply got a letterhead saying the money had been deposited.

Some lower income tenants tend to pay via cash or money orders and you could have them deposit it direct into your account and text you the receipt for you to input.

You will want to sign a short term lease agreement and get proper deposits for them such as last month and security.