The mortgage has nothing to do with it.  Her gain is proceeds less basis.  You didn't tell us selling expenses, but they would reduce the gain of $268,500.  She qualifies for the $250,000 exclusion, but you still must file to claim it.  Are you sure of the basis?  Is that just the original cost, or does it include improvements over the years?  Is she a widow?  Did she qualify for stepped-up basis when her husband died?