I realize after this experience that we need to have a more formal process. 

I've recently formalized my business by creating a corporation. 

We have a formal treasurer who leads with handling the finances, which we can request at any time to see.

If I did approach him about this I would use an attorney to formalize everything and do my due diligence on his business model, but what else should to protect both of us? 

I know a formal inspection will tell everything I need to know.

As a result, the smart REI investors are looking for B-minus or C-on-the-borders-of-B areas.Fountain Square is the neighborhood where a lot of REI's [including ME] are trying to find properties - thanks in large part to HGTV's "Good Bones". 

Now my question is how do I go about formally asking the seller to make the repair? 

It's not too much of a stretch to think this will increase the demand for housing just south of the border. 

Well, he died and his kids have the property, and they are having an auction house auction everything off - the house with some land, another chunk of land separate from the house (which borders my house), personal property, etc. 

I would take careful notes of how the story changed and send a formal demand for the return of your security deposit - I'd fight it for justice, but there isn't shame in backing away (and not giving them any more money) if you're not up to the fight.