I'm so sorry that you are having to deal with this mess. Leave, it's that simple. I'm speechless and sending hugs.
I thought I had problems and was here having myself a pity party tonight and then I read this.Sorry you all are going through this. I'm really sorry about your living conditions with you BIL. That is way more than scary to me.
Just to give a fair representation of how the parents have handled bil's legal problems in the past, let me share their "defense".
When he was arrested for the assault and went to court, they managed to keep him from doing prison time because he was "mentally deficient" with an I.Q. barely above mental retardation. They also managed to get a psychologist who was of the opinion that bil didn't fully "understand and comprehend" that what he did was wrong. To further aggravate matters, an extended family member is a counselor (who I will not be seeing, btw) and testified on bil's behalf. The little girls father was also persuaded to testify on behalf of bil, which is why the divorce happened. Little girl's father said, "God forgives him and so do I." This is an entire family that literally has circled the wagons around bil. This family was successful in seeing that bil didn't do prison time for attempting to rape a toddler! And how they managed to keep the FBI from pushing the case forward, I'll never know. I realize bil is "different" and I realize he has mental deficiencies. However, he holds a full-time job, makes major purchases on his own (vehicles and such), is getting ready to be married a second time, etc. He is not so limited that he doesn't understand what is right and wrong.
to you. I am so incredibly sorry. 
It sounds like they did because of their difficult circumstances but that the OP felt it would be ok since they are in a separate house on the property and she's with them all the time. I agree, not good. But these are the circumstances they're dealing with now.I am not sure I read this thread right? Did you and your DH know that bil was a pedophile and still move back there onto the gp's property? If so why was that even an option in the first place? Who does that?
You say DH is a good dad and husband, so give him a chance to prove it. Take him to a nice neutral place (restaurant with just the two of you comes to mind), and tell him what you stated here. Explain that the future has changes involved, and if he want's to be part of it:
1. He must agree to move immediately, even to an apartment, but it must be now.
2. He has to give up control of the household money. He will be allotted a certain amount of "fun money" once the budget is under control.
3. He must attend counseling sessions with you.
If he is truly a good guy as you mentioned, he will agree in the interest of his family and your relationship. Sometimes we men need to get to the brink to realize how much we love our wives, and how much we take them for granted.
If he is just in it for convenience, you'll find out that you need to go the attorney route.
The BIL is sick and will not get the help he needs, so don't waste your time trying to fix that. Just get your kids out and away from him, NOW!
Prayers sent for you to have strength and hopefully a good outcome to this trying situation.
Firstto you. I am so incredibly sorry.
I'm going to be frank with you here. Do whatever you can to protect your children. (I stopped reading after the post I pasted - it just JUMPED out at me -so forgive me for missing information and I can see what a strong woman you are anyway)
I'm 43 years old. I have what I would consider a "good life" and am thankful for it. HOWEVER, I am still unraveling the damage of a pedophile uncle who lived and vacationed with us, my parents' choices (who I love), the effect on sibiling (who I love) interaction (he went down the line) and my sexuality which is and should be a precious part of life.
I am not writing you for shock value. I chose not to PM because frankly I have no shame at this point in my healing - nor should I.
BUT I AM STILL UNRAVELING AND DEALING. Not because I won't get off it because it won't get off me in some ways. Life goes on but people really don't understand that you can't just think away the outcomes or effects. You try to just to live and move on and forget but somehow it infiltrates in ways you don't even understand yourself. One thinks certain reactions to the opposite sex or intimacy or even "living" is merely normal.
Your children are precious. Do not roll the dice. Get them out of there.
I am sorry for the position you are in. Truly.
(And to any parent that ever finds themselves in the sitation where something has happened - trust your instincts if you suspect -but most importantly YOUR REACTION can greatly improve the outcome for a child. Tell them I'm so sorry that happened to you and that I wasn't there for you. XXXX is very ill and has problems. This is not about you at all. And just get them early help. )

I am not afraid to speak.
I was raped at 13 by a pedophile.
1. No cure exists for pedophiles. None. Once they start they never stop. Jail is the only CURE!!!
http://www.perverted-justice.com/
to you & op for all you you are going thru & prayers for a better future.