So my interpretation of exempt vs. excluded is not correct. Section 121 says in plain language,
Gross income shall not include gain from the sale or exchange of property if, during the 5-year period ending on the date of the sale or exchange, such property has been owned and used by the taxpayer as the taxpayer’s principal residence for periods aggregating 2 years or more.
https://www.law.cornell.edu/uscode/text/26/121
Separately, of course, we could wonder how a taxpayer could pay "more than half" of a person's financial support when that person has a substantial capital gain from a property and no other income (or why you would want to support your freeloading relative who is sitting on a fat stack) But that's an audit issue. Under the code, it appears that if a person has less than $4700 of gross income, and has less than $250,000 of qualifying gains under section 121 that they do not use for their support (maybe they invest it in a non-income generating account, or use it for someone else's support), and you pay more than half their living expenses, they qualify to be claimed by you as a dependent.
