One question: when you say you found this "during the walk through" do you mean during your physical inspection, and before you removed your physical inspection contingency? Or do you mean during the final walthrough, which is usually done within 5 days of closing? Have you removed all your contingencies? If you have then you definitely need to consult with a real estate lawyer before you cancel, or you may be in jeopardy of losing your deposit. I know it sounds like it makes no sense, but the seller could try to keep it, so make sure you know where you stand.
It sounds like you are dealing with a stubborn seller. Or a seller who is getting bad advice from their agent. They will indeed have to disclose this problem to any future buyers, and they might put themselves in danger of getting lower offers... so they have a lot to lose. We had a seller who was like this, and refused to fix an air conditioning problem that would have been only about two thousand dollars. That buyer walked away and we ultimately found the seller a lower offer about a month later that she should have also taken but did not. Now she would be lucky if she sold the unit for $150,000 LESS than the lowest offer we got for her, because while the high end properties in LA have held value some of the condos have not. Being stubborn definitely has its price.
Have a long talk with your agent and perhaps a real estate attorney, because a seller can hold on to your deposit and make your life hell, no matter how wrong they are. This is just the way the law is written and you can spend months dealing with trying to get the deposit back... no matter how right you are!