If they return it in good condition, they can still get their deposit back without penalty for breaking the lease.Don't get caught up in childish games because the tenant has the advantage by making your life difficult for a long period of time.

Neither has room for a third condition.

You are going to need that picture so you can remember the property and the physical condition it was in.

If you can get a non recourse loan with the same terms and conditions then take it. 

What is a prohibited transaction?

There are times when there are those who are deceased or divorced just to name a couple that mean the property could still be in good condition. 

Ok,I'm a little devil and tempted to say " That's there problem,not yours".However,unless you are not going to have the property appraised before the closing (I severely doubt that),she is gonna find out anyway and demand a higher price or tell you to get lost.Be the helpful person and suggest it is going to appraise much higher and show her the comps for a home in her area and physical condition.

Anywhere, any condition, any price range.  

The condition of the house is often an I dictator of the condition of the title. 

I got it into "livable" (tolerable) condition and worked my freakin butt off with sweat equity. one paycheck at a time I would buy a little more.