Here's what I don't understand: you seem to want to claim Both that there is satisfaction of the "2 out of 5 years" residence test and also there is the "more than 1 year ownership" rental test. Yet, neither applies. And they are conflicting.

These people were tenants in a home they did not own for your "2 of 5 years" test.

These people never owned a Rental. They lived in the property. That's why the "more than 1 year" test doesn't apply.

Why not start with the basics: have you got the info as to the FMV at the time of transfer? Have you confirmed this "gift" really happened with all legal requirements? Have you confirmed the gifted amount per family member falls in the Gift limit?

And all of that is why the prior ownership doesn't carry over to the new owners for purposes of your question.

There are not enough details here, really.