It did flood and did minor damage to it but we kept it and I told them prior they are responsible for anything that happens to it so we let it be. 

Don't confuse clean with damage.

If not, what is the damage of rejecting their request?

Once this happens buyers look at your property as damaged goods and any offers that come in will be discounted.

Window blinds would be typically damaged from tenants trying to peep out to see who is outside at every possible noise.

Demo all the drywall out, remediate mold, complete reshingle of roof, replace all windows, replace all outside soffit/fascia/dormers, replace all siding, repipe whole house, rewire whole house, redo all mechanicals such as hvac, redo all interior and exterior doors, paint interior and exterior, replace any framing or insulation damaged by mold/water leaks, replace all gutters, minor landscaping, minor outside repair of concrete wall, install all new cabinets, install all new countertops, replace everything in 6 kitchens, replace everything in 6 bathrooms, install handrails,  install significant flooring and minor subfloor repairs, and install all trim in house.Project will cost around 150,000$.What would be fair for this?

I feel that there is more damage to inside of the house that leaked sewage that I don't want to be held responsible for.- He has now given me the ultimatum  of either me and him finding a solution that is  "fair to both of us" or I move out.

It is easy to replace if a piece gets damaged and is much more durable than carpet.Keep things neutral and as you do repairs, look to see if there are items nearing the end of their life that need to be replaced and don't replace them with the cheapest item available. 

An umbrella policy is a good alternative so long as the damage doesn't go above the coverage amount, which is usually one million dollars.

Your state may or may not require you to mitigate damages by attempting to re-rent asap.