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Epoxy isn't soluble in water, diluting your colorant in water would be a very bad idea. Also, many of the dyes sold are alcohol soluble, which also doesn't work well with epoxy.
The best colorant for epoxy is a product call Mixol. These are small containers of concentrated oil based dyes ($6/bottle) that work very well with epoxy. Oil based artist pigments will also work; both can be found at most artist supply shops.
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Transtint works great in the epoxies I've used to fill knot holes and cracks. It only takes a drop or two. Use a dye that's lighter than you think because it's so concentrated it will be darker than you expect. Sorry, no idea whether it's a good idea to put some wood in the hole first; I've never filled a hole quite that large. My guess is that partially filling the hole would be OK, and save some epoxy. Try it on some scrap to see.
John
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Transtint works great for the color. All I can say, as I know there are other options, but I haven't tried them.
As for filling The knots, the West System works great, but you need to thicken it with one their fillers. I have been using #406 with great success. You can just add the filler to be as thick as you need it: from catsup to mayonnaise to peanut butter (their description). 1" is a big hole to fill, and I would definitely stick something in to help fill it...the original knot would be good if you still have it.
Bob
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Personally I usually just use the epoxy with no tint at all, although on occasion I have mixed in sanding dust from whatever wood I'm using, don't like it too much, and I have used dowels in smaller holes, seems ok.
But by far my preference is just the epoxy.
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I've mixed black powdered Homestead dye into 5-minute epoxy to fill knot holes. You really don't need that much. Works great.
To make cleanup easier, I encircle the area with painter's tape then spread the epoxy into the hole. The epoxy that dries on the tape is much easier to peel off/break off than if it comes in contact with the bare wood. I'll use a wide chisel bevel down to make it flush to the surface.
Paul