sheepstache,
Your misgivings are justified. I'd refuse to take it in this manner. Ignoring the obvious ethical issues, it stinks of fraud and even if she makes it for more than five years, the medicaid look back rules are not unlikely to be extended back as government finances get tighter. If decision is made to do it, I'd bite the expensive bullet and go to a competent tax/estate planning attorney.
Here are some relevant thoughts/questions, though:
How much is the house worth? Unless it and any other assets are pretty substantial, there shouldn't be much in the way of federal tax considerations, although she would eat into her lifetime unified credit amount of 5mill--and may have to file informational return (I'm not sure on this part). She and/or you may also face state tax liability, depending upon where you live.
She can, of course, give each of you a gift of 14K (rises with inflation each year) annually, or 28K total. If you have kids, she can give each of them 14K a year as well--or, give $$ to 529 plans. Even these legitimate gifts, however, may run afoul of the lookback rules.
I do not specialize in tax law--and I know next to nothing about medicaid rules in this area, but you are right to be concerned. If you can't talk her out of going this route, I'd get an expert involved--either s/he can convince MIL that she is on the wrong path, or can structure it in a legal way (if possible). N.B. even though there might not be medicaid law specifically aimed at the son in this situation, there are a plethora of federal criminal laws that could easily be applied to nail a recipient who participates in such a transfer of assets. proceed carefully.