The legislation changed last December, the paragraph which disqualified a person from receiving MIS if their house was for sale was removed.
The intention of the change was to allow people already receiving MIS to continue to be eligible if they put their house up for sale.
From a quick read of the legislation, it appears that removing the paragraph in legislation doesn't specifically exclude people like yourself, who apply for MIS while the house is for sale. This might explain the inital refusal and be a loophole that you could argue on appeal.