Not the best situation, but not the worst.

The house was appraised for 400k, he refinanced 70% so he got 280k loan. 

House hacking helps you grow wealth and cut down on your home loan costs by letting others live in your place.

I am really stating what I would do in this situation

The sellers interest is the interest and transactional convenience, when a lender is involved there are costs associated that can often be rolled back into the loan provided the loan to value (LTV) based off the appraisal is sufficient. - Higher rates.

The loan we were applying for is an FHA, which stipulates we must provide a signed lease for our half of the duplex (to be newly rented out) but for the other half which the parents "own" (in reality all three are equally owners of the entire property.) we would need to provide proof of rental income on our tax return, however her parents claimed that so we seem to be SOL.The mortgage is covered, we can rent it out no problem, but the underwriter is saying on paper it looks like she is responsible for the whole duplex and the rent for half of it is unreportable.

The seller however does not have any documentation to show he made any reasonable efforts to evaluate the borrower ability to pay the loan.

It’s been the best situation for both of us so I want to replicate this somewhere else 

I certainly would.Furthermore, in this particular situation, is the seller aware of the AFR, which is an acceptable federal rate? 

The loan is conventional and they are asking for Employment Verification saying I work remote in order to settle the occupancy rule.