If the illegal unit looks like it's inhabited then you will not be able to close with FHA. 

The Oregon Coast is ground zero for regions of the country that will in many ways become more inhabitable as temps rise, water dries and abundance of resources is more critical.

There's a real good chance that the lease requires them to do several things: upkeep on the unit is a big one (damage to property), weeds outside and landscaping (which encourage pests and insects to inhabit the property), pets authorized or not, additional tenants on the property that are not on the lease.

His plan involved reframing some of the building and inhabiting illegal tenants.

As a new civilian, I am now a 1099 employee and do not have any W-2 income. 

They need to sign something acknowledging that they are giving up their rights to inhabit the house in exchange for money.

Next year I will return to civilian life and make around 120K a year ( + or - 20K).

@Basit SiddiqiI have a CPA and have used one from 2019 forward because I work overseas as a civilian defense contractor, so I need the assistance of a CPA to handle the FEIE as well as the K-1.

Mortgage is $3k / mo so it should be able to cash flow well once inhabited. 

Needs a few repairs, but definitely inhabitable) with a small 6 unit in the back.