Sell the house.2.

The only reason I see not to take the lower rate is a plan to sell or refinance within 3 years or less.

As for pros/cons of keeping it:Cons: 1) Poor cash flow to value, 2) Managing from afar has extra difficulties/risk, 3) No cap gains if you sell nowPros: APPRECIATION: San Diego historically has produced outstanding return for long term buy and hold.  

Kids decide they don't want to continue renting it out and sell it and current market value is $3 million.

What I have found is if I sell my assets on the island, I could probably 10x my assets in the states, by not putting so much effort down on the island.

The property is currently under an FHA loan locked in at 2.5%, which means I am unable to sell or refinance at this time.

Then she will save at least a small boatload of taxes by not selling before her passing. 

Buy and hold, 3 to 5 years, refi or selling at term.

There was more to the proposition than just this (a relaxation of rules allowing those over 65 to move and keeping there current prop tax basis as a way to sell it), but guess who both of these benefit - hmm, more homes selling?  

He wants to cash out and is willing to sell me the property for market value.