I did put a cap on the utilities and he would be charged 1/2 of the difference so he wouldn't leave the HVAC running, even when we weren't there.

I tend to worry easily  When you ask a bunch of RE hammers what to do, they will say to find a nail.

You hit the nail on the head, the most important thing to do is fix the source of the problem, the driveway/water issue.

Hey Sean,Mike hit the nail on the head with price range, but I am local Memphis agent and would love to connect any time to work through some options. 

In Arizona drywall is inspected for proper nail/screw placement before taping and to make sure wet locations have denshield.  

To me, it looks like there is a chance that some sandpaper and repaint would 98% make it look acceptable.Until the turn you cold put anything up there to barrier the dogs nails from the paint and wood.If they are good renters you want to keep them, maybe offer a doggie door in the back door (???)

I'm not sure but some states might have a cap on how much you can raise the rent on a tenant that is already in the unit renting.

One more thing that happens is that the floor has been sanded so much it doesn't have any more wood left above the nails.

After work, every night for a month I spent hours in Home Depot buying anything from nails and drywall to kitchen cabinets and plumbing.

Katie, I think you nailed it here.