Our decision largely hinges on the earlier question - is there a step up in basis when my mother in law passes away? 

Best bet is to go to the courthouse and file the paperwork and let the judge make the decision.

From those remaining options I'd research each individually and make a decision about next steps from there. 

Please advise on the best option(s) for our family, as well as if I am missing any key info needed to make this decision.

After my daughter was born and making the decision for my wife to stay home full time I knew I was ready to get started!

Understandable that you're feeling about a bit unethical about the decision one way or another. 

If I were to house-hack and purchase a multifamily home and stay in one of the units, is it a wise decision to use a FHA loan to purchase the property?

In my state the reason deposits are held in escrow accounts is so a neutral third party has the money in the event of a conflict like you are describing.Your first mistake was to get into a hurry: I could be completely wrong but it sounds like you made a hasty decision based on emotion and not on what may have been best for your situation.

That way, you can make the best decision for your specific property.

He's been willing to help a rookie investor like myself, answering questions, and advocating for me to make safe decisions.