Yes, the "holding period" transfers under § 1223(2), which makes it eligible for long-term rather than short-term capital gains, but my understanding is that doesn't apply to the § 121 ownership requirement.  

In response to TaxGuyBill's last reply, I don't think we know what type of co-ownership they have in this particular situation, and even if we did, it sounds like we both aren't 100% certain about how that impact the § 121 treatment anyway.  I think my understanding of it is probably correct, but it is possible that one or more of the types of co-ownership actually means they qualify.  It's also possible there isn't a definitive answer to this if there haven't been any tax court cases, PLRs, etc. on this.  But if they don't take the exclusion on the gifted portion, that would be the more conservative approach at least, but not as beneficial.