The first stimulus check was received and returned to the IRS as the recipient had already passed. How do we reflect this in Turbo Tax?

Report that you received zero for round 1, since it was returned.  Turbotax will give him the recovery rebate of $1200 for round 1 plus $600 for round 2.  This is correct--under the law, any "taxpayer" is entitled to the rebate, and your father-in-law is a taxpayer for 2020 if he had income and you are filing his final return.  Yes, this is different than what the IRS said last year, but that's bureaucracy for you.