You can't keep the item and their money, so refund in full from the transaction in your PayPal account if you can. If not, you will have to contact PayPal to see if they can action the refund manually.
In future, bear in mind that you have 32 days from purchase date in which to cancel an Ebay transaction and get the selling fee credited back to your Ebay account. So holding an item for a buyer beyond this point is never a good idea, as you will be stuck with the fee.
If this was a collection item, bear in mind too that you should never accept PayPal for these - cash or bank transfer only, once the buyer has fully examined the item and is happy with it. If you accept payment by PayPal, you will lose an Unauthorised Account Use claim as the only thing a payment processor will accept for such a claim is a proof of posting receipt, proving dispatch to the account holder's registered address. Signed receipts etc are not accepted. So you would lose the item, your money, and be charged a hefty admin fee into the bargain.
@theladysnotforburning
