Terrel, an outdoor covered patio is a livable space. The design, which is mostly a roof over slab and fully open on two sides , with a couple closets at the back, is functionally not much different than a detached covered patio.
But even if that wasn't the case, then, you would have just recommened painting the interior and exterior of the rotten collapsing structure to comply with the other safety issues but the collapsing portion of the safety issue could be ignored because you could deem it not a living area in the subject yard?
I'm not trying to be a smarty pants here, I would have been much happier to concentrate on the appraising rather than feeling shackled by FHA/HUD protocols and making demands, if there was some sort of FHA/HUD loophole.
Other logical choices, especially after speaking with the homeowner (like reconstructing the shed was not even a consideration for her), were and are not apparent to me.