In case anyone else is as confused as I was by the obtuse language on that form, I'm going to answer my own question. I finally realized the CA FTB means this:
1) If one's last use of a property, regardless of when, was as a principal residence, then the sale of that property is not subject to withholding.
2) However, if one's last use was as a rental, vacation home, etc., or anything other than a principal residence, then one must satisfy the rule of having primarily lived in the home for at least 2 out of the 5 years prior to the sale in order to be exempt from withholding.
This would have been far clearer had they even reversed the order of Part III Lines 1 and 2.
