Everything is negotiable of course. The most important thing is, do you still want to move forward with the purchase, if yes, then the second issue would be to see what you can negotiate with the seller. Most seller's would be reasonable and determine it is an existing issue which would only have been revealed with an inspection.
It sounds like you had an inspection contingency on the deal since you performed an inspection, is that correct? If the seller refuses to correct the issue or offer a monetary concession for you to repair the issue, then at that point it is totally up to you to either walk away of move forward with the deal.
I would probably speak to a water expert to see what options you have and how much those options would cost, that way you can go into the negotiation well informed. Of course your Realtor should be doing the communicating for you, or call a meeting for everyone to meet to hammer out a deal.