In an LLC entity it is the LLC that recognizes the gain and subsequent tax from taking the boot to buyout the investors. 

If Susan is a nice person, she would appreciate that your tenant recognized the problem and she would probably not do it again.

(There are exceptions)@Richard Boyd , although the rules do allow the exchange between related parties, if the father then sells the property to the gas station/ third party, the gain has to be recognized.  

If you have what it takes, someone will recognize it and give you the opportunity.

The positive side: Josh recognized he was a bottleneck and opened our communication to additional people (Mike and Elyse) who’ve been helpful in answering my questions after each update.

If this was true lease option, payments made before the exercise of an option under such an arrangement generally are recognized by the lessor as rental income and deducted by the lessee as rent expense. 

Property values go up because demand, inflation, and value-add increase the price of the house more than wear and tear decreases it, so the effect is masked and not recognized.

2) Would this work differently at the federal level vs. would the state tax authority likely recognize the MSA and award him the state deduction 3) What legal action could he reasonably take to contest my claiming the deduction, especially if it were to be granted by the IRS and/or the state tax authority?

An option to making this would would be selling on an installment sale- so that you are only recognizing part of the gain each year, over a few years.

Banks aren't lending because they haven't trained their people to recognize risk now that automated credit scoring (fico) dictates approval.