Since she did still live in and own the house for 2 out of the last 5 years, she still does qualify for the home sale exclusion. However, when the house was a rental, it should have been depreciated on their taxes. Since she is now selling the rental, she will need to recapture the depreciation on the home, meaning add back the depreciation taken as ordinary income.
As you walk through the questions reporting the sale of the home, you will be asked if the home has ever been used for anything other than the primary home, here you will answer yes. As you continue through you will be asked about depreciation taken on the home while it was a rental. This is where you will enter the depreciation for the entire rental period. You will need old tax returns to find this information and then look at Schedule E from the return to find the amount for each year.
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