Q. I found a bit of a nightmare beneath wet, well-rotted clapboards. My concern is weather-proofing the corner adjacent to the chimney properly. Appreciate your feedback.
Not a lot of info, but your picture told a lot more. The outside clapboards are rotted. I don’t know how far, but far enough to be a problem. Inside, joists, studs, and other structural members are rotting badly. It is due to excessive moisture, water vapor building up in the basement with no place to go except through the walls to condense on the back of the sheathing, then through the siding, rotting everything in sight and not in sight. It may not be occurring in heated upstairs rooms, but it can happen. It takes a long time, so I am surprised you discovered it so far advanced.
The decay of the wall studs and ceiling joists is due to water vapor coming up through the concrete floor and condensing on cool materials, such as those studs and joists. You cannot stop it without an expensive vapor barrier system.
How to fix it all? First, ventilate that basement. Open all windows to get some cross-ventilation through the basement. If there are no windows, install vents as high as you can. If you have a dehumidifier, turn it off and let the venting do its work for free. A dehumidifier is expensive to run and sometimes is too efficient; it will clear the air of water vapor, and won’t stop there. It will continue to pull water vapor right through the concrete slab. If you run it, use it at half speed or every other day.
Now comes demolition. For the area where the clapboards are rotting, take them off, and the sheathing too if it is badly rotted. Otherwise, you can keep the sheathing on, then put 3/8-inch Styrofoam insulation on the sheathing, then put on siding. The insulation will insulate the sheathing enough so that moisture will not condense on it because it is too warm.
For the rotted joists and studs, take out any insulation between them, and check the joists and studs; if they are in fair shape, cut out any decay and treat them with a 1-to-3 ratio bleach-water solution; being dry, they will stop rotting. If too far gone, take them out and put in a joist or stud, preferably pressure-treated, just in case. Also replace any rotted sills on top of the foundation. You will need to take off any rotted clapboards and sheathing first. As for insulation in the basement, use rigid foam Thermax or High R Sheathing. Put in 4 inches and you will have adequate insulation tucked between the joists.
Then rebuild the whole thing, making sure there is a flashing between the wall and the chimney. Sometimes you can put in a 1-by-2 or 1-by-3 board, notched to accommodate the contour of the clapboards, and well caulked against siding and chimney, on both sides.
If you need a professional, hire a renovation contractor who knows more about existing houses than a regular contractor.