This now sounds like wear and tear that won't be covered by insurance.

Once the tenants vacated, I realized I severely underestimated the amount of wear and tear the property sustained after they've lived in it for over a year.

I highly recommend tearing down these old properties and developing new ones.

As it sat it was worth less than $100k but somehow the owner figured out I owned the lots on either side of him so he wanted $200k for it plus I had to tear it down for another $20k or so.

Rule #5: Turn your rentals into bunkers as tenants are tenants and they will destroy your property through "Wear and Tear".

Depending on different factors, primarily lot size and location, we have even been paying $1m+ for houses to tear down in Seattle and $2m+ in the Eastside . 

People looking for self storage really don't give a **** about the paint or carpets, so you can leave it as is, tear out the carpets, whatever.

I never want to be the first to do anything. garbage deal let it go. you are talking about council variance, constructing or renovating a structure, you won't be able to get a permit. not advice but not to by the deal and not to look at the adu as anything but garbage anyone who says any differently should look at a zoning map and show me why and how an ADU makes any financial sense. you are only getting yourself into a very poor situation. tear it down and move on. 

I believe it's arguably a tear down.

You don't know what the house was like when he moved in and it has been 13 years, so some of the things you will find are part of normal wear and tear (eg if you need to replace carpet, repaint, etc) not damage that the tenant did.