Last thing I want is to get a duplex only to realize it's only legal to have a SFH in there.

Without a building permit you are going no where.You are also looking at 10s of thousands possibly to bring it up to code.

Many know that the Civil Relief Act permits active duty military to break a lease when they recieve orders or depart from service.

This is not legal advice:They'd contact you to negotiate a settlement if they plan on closing.

That $1000 could either be refunded to us or credited on the next tax bill which we chose to do the credit. about a month later the lawyer who completed our transaction sends us an email saying the sellers lawyer knows that we ended up getting a tax credit and that it is owed to the sellers, and that they would take legal action if we didn't refund it. basically my question is how does this usually work out, are they entitled only to a prorated amount of it, are they even entitled to any of it?

You may have to get creative...find a duplex in a good area and Airbnb the units or find an SFR with a legal accessory dwelling unit and live in the smaller unit while renting out the main etc. 

But,  the owners have the legal right to the house. 

The last item was "no permit or drawings on file to duplex first floor to basement".

Has anyone partnered with an owner to flip a house and if so I did you legally structure the deal?

He's always had that 'hustle', it just took him some years to apply it to legal endeavors like motorcycles and car audio, haha.