Totally legal to rebate to a principal to the transaction. 

Keep in mind there is still a max loan amount tied to the number of legal unitsA legal 2 flat in those areas can easily be above $1 million, but with a loan limit of $700k you need to make up the difference.  

And in some cases the expenses for legal fees can be double or treble the original judgement amount by the time the debt is recovered."

The LTVs are to restrictive on non owner occupied properties to make sense.  

If your wife has reservations about the legal partnership, she must have her reasons.

I'm not sure of the legalities of doing this, waiting to hear back from my attorney but wondering if anyone here has any thoughts.

Seek competent tax and legal advice.

And then when you come back you convert the rental back into your primary residence so it will once again be eligible for the 121 exemption.This can work but there some big restrictions when the primary you sell has been converted from investment. 

If you wait 6 months the acquisition loan amount restriction no longer applies.

I was curious what legal grounds I have to their offer since their notice clearly states the price they are asking for.