There’s more wrong than right in that “room”.
Violations with the HVAC, Electrical, and Plumbing!
Refer them to the AHJ if they want approval.
Are we sure this is not a picture from the new “House Of Horrors” ? 
Im impressed with how they got that all in there behind the toilet and sink.
Trust me I have a list written in the report on this one. But for some reason they’re stuck on the intake vent for the furnace.
I bet Ben could get some new ideas from this one.
BTU vs. SQ footage required for vented or unvented areas.
With everything mentioned mentioned above I doubt you have 24 inches egress in front of the toilet.
You are correct!
Does it have an open ceiling, with visible floor joists?
Nope. Its enclosed.
Then in my opinion from what I can see in the photos you were right calling it a confined space issue.
Why the back and forth with buyer and lawyer? Where are the qualified HVAC, plumbing and electrical contractors you referred to in your recommendations? Stand by your written words and get the hell outta Dodge, lol.
Scott, in my opinion all you can do is identify the things that you see that are “wrong” or not ok, and why, and leave it at that. I’m not sure why you feel it necessary to declare it a confined space, where does that go? Just explain the problems with make up air and other issues with it all jammed tight into one small area. And let them know that they don’t have to fix anything just because you identified it, they must weigh the risk and decide what to do.
I never understand why people argue with us about things we identify. We aren’t a codes official or someone that has to signoff on the livability of the house, or require things to be corrected to perfect before we give them an occupancy permit. Our report is not a mandatory fix report. We merely identify things we think or know are bad that could be health or safety issues, and let them then decide what to do about it. Obviously the seller has been living there and found all that arrangement acceptable. Is it ideal, or a standard setup? No. Are there some items that pose a major risk? Yes. If the buyer doesn’t like something the way it is, he can ask for it to be fixed or accept it as is. But no need to argue about it. I’ve yet to find an easy way to explain that to clients before we start the inspection process that actually gets their attention and is easy to understand. Good luck.
Or, he can pass on the house… 
Simple. This is a result of failing to set the clients expectations. I find this to be more of an issue with inspectors that do not answer their own phone, ie. using a call service that works off of a script.
90% Furnace Intake is coming from the top of the furnace, SO …
Total btu of Furnace and water heater = X
X / 1,000 = Y
Y x 50 = Z
Example = 100,000 + 40,000 = 140,000
140,000 / 1,000 = 140
140 x 50 = 7,000 cu/ft
Now measure the room = HxWxL = ?? cu/ft
NOW … Is there adequate make up air ??
BUT the room is WRONG due to just inadequate clearances of electric pane, w/h burner, etc
Did you happen to mention that the extra methane gas might dangerously raise the natural gas btu rating? LOL.
Honestly before I even start the inspection I explain exactly that. And I tell them I may find issues that they are not “happy about” but everything is either negotiable and or fixable. And after my inspection is done its up to the buyer, seller and their interested parties to work out the details.
I agree 100%. Yesterday the attorney called again. I explained to him exactly what you just said in different verbiage and I also told him the client can walk away at anytime if they feel its that big of an issue. And I also joked (but not really) that the next time he called me about this issue I would invoice him for for consultation fees. LOL