She can still get her exemption of $250K which would cover all of the gain. 

I think one thing you will need is Builder's risk insurance to cover while you are rehabbing. 

Assuming it cashflowed at least enough to cover the PITI, plus the HELOC payment.

Here's an interesting one: who is responsible -->My client sold a 4plex - in the negotiations they agreed to cover costs for a Home Warranty for the new buyer. 60 or so days later - the property closes at a title company.

It really reinforces the need of doing a proper screening.

Didn't screen properly.3.

I do heavy phone screening and email MS-Word applications. 

Importantly, these companies also buy insurance to cover the cost of buying out the exiting partner.

Would a renters insurance policy have covered an incident like this? 

FHA, VA, and Conventional mortgages each come with their own set of rules and requirements or the condition of items such as the roof, plumbing, appliances, peeling paint, floor coverings, etc.