What I don't want to see is the throwing of good $ after bad AND the upside of selling at a loss now is that we will know what the loss is and can start the "rebuilding" immediately or whenever they feel up to it.

We have a fair amount of relevant experience including many rehabs (over a dozen) and right now are rebuilding two heavily fire damaged units (over $200k damage), but no ADUs.    

Ours is completely custom... knocking down our garage and rebuilding a 1,030 footprint structure (2,060 total sq ft).

The tenant (me) can buy a policy which covers the landlord's building, enough to rebuild it from the ground up.

I would break down your strategy to the nuts and bolts and rebuild.

You also need to have the rebuilding costs (Building Replacement cost) updated to include the changes to the basement. 

I had done some volunteering with All Hands and Hearts rebuilding homes in Yabucoa in November, and there is still much work to be done and houses in tough shape.

I love old windows and have become really good at rebuilding them. 

Also, the river has flooded before (I don't think it will again because they built a huge dike), but it caused a lot of clearing/rebuilding, and lots down there go for a premium price because it's pretty with mature trees. 

so we will be "modifing" the current addition, even though it would be much easier to tear down and rebuild.