Why not try to strike a deal where you agree he can leave early and he agrees you keep the deposit? Just make sure it is in writing. But yes, otherwise you would need to return it if you are following the law.
You need to talk to a lawyer. Charging for a water bill could cost you more than the security deposit, unless you do it correctly (and it's almost impossible to do it correctly ).
There are lots of rules about the security deposit too. Of the tenant asks for the security deposit you MUST give it back immediately.
As with any advice given on this web site, please contact an attorney so ALL facts can be disclosed before any action is taken
You have to be very careful with the security deposit law and in separately metering utilities. Your riskiest course of action is to do nothing. Less risky would be to place the money into a separate tenant's account. The safest thing to do would be to return the security deposit. Once returned, your liability is probably zero. Whether you are in the business of renting properties or not, certain violations of tenant-landlord law carry penalties like treble damages and an award of attorney's fees. If you are going to continue to be a landlord, you should have legal counsel to assist you in the enterprise. Making a mistake is far more costly than paying legal counsel to help you avoid them.
Dealing with the security deposit is easy at this point since you have no legal right to it. You must either return the security deposit to the tenant upon demand or within thirty days of termination of the tenancy. Your failure to place the security deposit into a separate interest bearing account secure from your creditors, gives the tenant the right to demand its return and prevents you from being able to deduct from it for owed rent and damages. Regarding charging your tenant for water, you have to be very cautious on this front. Landlords are required, among other things, to install efficient fixtures, ensure that the water is separately metered to the unit against which it is being charged, etc. There are too many requirements to go into detail here. You could be subject to liability for failing to comply with the requirements. Although you may not consider yourself in the business of renting out properties, that is absolutely the case whether you rent 1 or 100 apartments. It is difficult to be a landlord in Massachusetts. I recommend that you consult with an attorney to keep out of trouble in the future.
This "answer" is for information purposes only and is not intended as legal advice or to create an attorney-client relationship.