Microsoft got back to me and they said this is by design...
Resolution
Web.config cannot be deleted to add controller as it is by design. Visual Studio will collapse if web.config is modified underneath.
Workaround:
Config files can include other config files.Web.config include a extensions.config and make an extensions.tt that just generates extensions.config.
Reference : Can a web.config read from an external xml file?
With your consent I am going ahead and closing the case. Please feel free to get back to me if you have any follow-up questions.
Thank you for choosing Microsoft!