Given that both answers include の, I feel like this question isn't testing me on what it thinks it is? As I was answering, I checked that both に and で can mean "in", so it felt like a complete guess as to which it would accept. Of course, I might be doing something wrong, given I'm still pretty new at this, but either way, two of the answers seemed like they were testing something other than の.
Thinking about it, it does make sense that grammar is complicated and sometimes you gotta' test multiple things at once. I guess I'm just a bit annoyed that this is marked against this particular piece of grammar that I feel I know pretty well.
Not totally sure if this is a question or not. Just felt like something I should bring up?
Different questions have different difficulty levels - while most of them focus on the single piece of the grammar, not all do. If you mark the sentence down with the arrow, it should not appear again.
As to the grammar, に and で have, among others, one very big difference. に is used to show a place of existence, that is, the verbs いる and ある. で is used to show the place of an action.