Mother in law dies and leaves house half too each daughter. One daughter would like to sell her interest. The other daughter would like to keep the house. Daughter 2 happens to be the wife of the owner of the Plan Sponsor. Sponsor would like to buy the house.

Is sister of wife of trustee an underlated party. Would real estate in the Plan be a good idea?

Issues as I see them:

1) Possible PT
2) Plan gets no depreciation
3) Owners convert possible capital gains into ordinary income.

Probably more

I think you've hit on the main issues. It seems a certain PT to me as the spouse of an 50% owner of the company sponsoring the plan is a disqualified person (party-in-interest) to be doing business with, even if she only owns half of the house. I also think practically speaking that if they want to "own" the house, then you must be careful not to use it for personal use if it's held in the plan (another PT) which may negate some of the reason for keeping it, along with the tax issues you already mentioned.

Depending on the usage of the real estate, you might have UBTI. However, since we are talking about a home, most likely any income would arise from rent or sale of the property, which should be exempt from UBTI.