You (and the owner) are bound by the terms and conditions of the contract. If, as you say, the contract allows you not to purchae, but you lose what you've paid towards the house, then that's something you've agreed to and the owner will expect you to act accordingly. (I'm more familiar with lease-options, which typically include the same provision. And if the option says that the option fee is nonrefundable, which most do, then it's nonrefundable.)
Can they force you to pay the taxes when you're not going to buy the house? If that's what your contract provides, then, yes. You agreed to it.
You've never seen an appraisal or report on the condition of the house. OK. Did the contract specify that one would be provided to you? If so, then you're owed one. If not, then there's no obligation on the part of the owner. You could always hire an appraiser or a home inspector. And, in fact, it would have been advisable for you to have done so (a home inspector) prior to signing the contract. As for the appraisal, you might have contacted a Realtor for comps. That's not a formal appraisal, but would have given you some assurance as to the property's value.
You say the seller hasn't produced anything saying the house is up to code. Did the contract call for that? Now, yes, the property has to be habitable. And, with a 100 year old house, it's likely some things, such as electrical, aren't up to code. A home inspector could have helped you with that. Now, you can always call up the housing inspector for Martinsville and see if the property's up to code. I wouldn't particularly advise it. If it's not up to code, then you might find yourself out on the street.
Best thing to do at this point is to talk with the owner and see if you can renegotiate the contract. It's up to him; he can say no. But if he's really interested in selling the house, he might extend the contract for deed. Or he might agree to refund part of what you've already paid. Or he might agree to lower the specified purchase price. Your leverage is that you're in the house and presumably been good tenants. Rather than trying to find someone else, the owner might make some concessions to help you with the transaction. But that's his call.
One other possibility: Is the contract for deed assignable? (Probably not, but it could be; you have to read it to find out.) If it is assignable, and your purchase price is below current market value, you might be able to find someone else who'd like to buy the property. You'd then assign the contract to them. For example, let's say the agreed-upon purchase price is $100,000. You say you've put $7,000 toward the house. Let's say the house, on the open market, would sell for $130,000. You might be able to assign the contract for, let's say, $15,000. That is, someone else would give you $15,000 and would receive your right to buy the house for $100,000. You'd receive $15,000. That would give you enough to cover the $7,000 you've put into the property, plus another $8,000 in profit. The other person would be able to buy the house for a total of $115,000--$100,000 to the owner and $15,000 to you. And the owner would still be selling the house for $100,000...just to someone else, not to you.
But: Read the contract and then go to a real estate lawyer for advice.
Hope that helps.