“ Is there anyting she can do to reduce the gain?”--->Matter of fact, as long as your sister’s marginal tax bracket is lower than 25% in 2010, your sister doesn’t have to pay any tax, capital gain tax, on her LTCG, $50K; if her marginal tax rate is 25% or more, then she pays 15% CG tax on her $50K LTCG, 15%*$50,000=$7,500 on her 2010 return UNLESS she has capital loss(es). If she sells the residence in 2012, then her CG tax rate will be either 10% or 20%. As she sells the residence in 2010 , she can save $5,000( $0 as long as her marginal tax rate is lower than 255 in 2010 as said above) or $2,500( as long as her marginal tax is lower than 25% in 2010) . If your sister has some stocks at a loss, I am NOT sure if she has, then she can sell the stock to reduce capital gains tax on $50K. Your sister can use this to offset the capital gains made on the sale of her ressidence. After 30 days, she can repurchase that same stock if she wants to avoid WASH- sale provision.
“ Can we use the Non qualified use option. Remember she only lived in the house for 5 months and then kept it for 7ish years so my parents could live there.”---->I don’t think so; in general, nonqualified use is any period during which the property is not used as the principal residence of the taxpayer or spouse. If there is a period of "nonqualified use" after 2008, the portion of your gain allocated to that period won't qualify for the exclusion. Nonqualified use usually reduces the portion of your qualified gain of $250,000($500,000 as MFJ) allocated for the exclusion. I guess your sister can’t meet the condition ( she needs to have lived in the house for at least 24 months in that 5-year period.). In other words, the home must have been her principal residence. Geenrally spwaking, The provision primarily affects people who own vacation homes or rental properties but convert them to a principal residence for a period of at least two years prior to sale. Generally your sister is treated as having qualified use during any period your sister, her spouse or her former spouse, NOT her parents, use the property as a principal residence. However, all other time is treated as a period of nonqualified use, regardless of how the property is being used, or even if it is not being used at all.