what does this mean? Literally the wine isn't wine, but colored water, or does this mean that the wine is watered down or something like that?
The ending of the adjective changes with the case of the noun. In this case "water" = "das Wasser", and the adjective ending with "das" is "-es". If it were masculine ("Der tee"), it would end in "-er". If is feminine (die Frau), it would end in "-e". Here is also a discussion on it where someone else asked a similar question: http://duolingo.com/#/comment/10061?from_skill=20a5dd4deb36bfa484843b075d1d9780
So 'rotes' is used because this is a Strong Inflection and Wasser is in the Accusative Case, right?
Strong inflection, yes, but rotes Wasser is in the nominative case -- predicate nominative after the verb "to be".
der Wein is in the nominative case because it is the subject.
rotes Wasser is in the nominative case because it is a predicate that says something about the subject -- such predicates are (almost always) in the nominative case in German.
There are no objects in this sentence.
I understood that Das can be translated as "this" or "that" as well as the standard "the". So why not accept "this wine is red water"?
rubs temples Listen Duo, I didn't come here to have existential crisis, I came here to learn German.
I said the wine is red water, it says the wine is red water, am i wrong or not?
Check to make sure you didn't get a listening exercise rather than a translation exercise.
If it still happens, make a screenshot and upload it, then link to it here; perhaps that will help us understand what might have happened.