I’d wire brush the treaded area first and start hitting it with Kroil or pb, etc. that might do it but maybe have to hit it a bit with heat, carefully. You got a lot of cleaning to do, but I bet it works fine once clean. You’ll need a proper flywheel puller if you don’t already have one. Might name her Katrina. She’s been through a hurricane sometime. Good luck.

Yes you have found the problem. My 400 had that exact same problem with water behind the cover, except mine dried that way and seized the flywheel. I got the bike that way for $100 because the PO thought the top end had locked up. Once I freed up the corrosion at the flywheel it fired right up. You will have to do some cleaning in there.

I've always been able to remove them with an air impact. But not with an electric impact. You might as well start soaking the flywheel nut with penetrating oil while you obtain a proper flywheel puller. Unless you have one already. Don't even attempt a jaw type puller. And it won't come off without a puller.

Fear not. You will get it runnng once you sort this out. The water was entering my side cover due to a crack in the cutout where the wire grommet fits in the side case.

This is why I got in the habit of pulling the ignition cover and oil pump cover after washing the bike.

Since it looks like oil is mixed in, you might want to check the crank seal carefully.

Here is another photo showing the most likely point of entry for your water problem.

That grommet is the guilty party on this one too. Would you believe I have the flywheel puller from the 70's when I worked in a Yamaha shop. Everything we worked on at that time was new or just a few years old. Nothing 45 years old. I have to find my air impact and give that I try. I haven't seen it or needed it since we moved into our current home 2 years ago. I was planning on building cabinets for my garage and getting organized until I became the owner of the 78 DT400 and this DT250 and bought a 2018 YZ250FX in January. The YZ is a beast! I raced in a hare scramble a couple weeks ago in the Super 60+ class. The black and white picture is me #206 on a 74 YZ250 in 1976.

Nice new bike! Yes the new stuff is way too much for me. My son has always had current dirt bikes so I get to ride them once in a while and I always get off shaking my head in amazement.
Love the vintage photos that are shared on this forum.
Obviously this ain't your fist rodeo, so I'm sure you got this.

Schu, its just like riding a bike...I am in pretty good shape, but the next day I had sore muscles that hadn't been sore in a while.

Looks like the flywheel rubbed through one of the coil wires. The flywheel is cleaning up, virtually no rust. Good call on the crank seal, the spring was hanging out.

Got the ignition all cleaned up. Teplaced the wire between the ignition coil and the charging coil. Changed the tranny oil, lubed and adjust all cables and chain. Started third kick! Check it out.

Congratulations!!!!