Thank you so much. They also received a 1099misc for “rents” which was for compensation while the project was being completed. How do I handle that portion? 

You're welcome.    I'd report the 1099-MISC on Schedule E 

Shouldn’t that also be offset and the basis be lowered? 

Not how I would handle.  I would report as rent income just like the 1099 indicates it was

Surface damages don't reduce basis, no.

Thank you