That's the way I would have done it.
Once the windows are on site you make a cut down the middle starting and finishing about 12" from the opening.
Then a diagonal cut in each corner toward the middle.
The sides and bottom get folded into the opening stapled and trimmed off.
The top gets cut straight across the opening and two small cuts are made vertical to form a flap.
The flap is to be used to cover the top of the nailing fin.
You apply caulking to the back sides of the nailing fin before installing the window.
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Yes, the tape on the bottom shows they didn't know proper install, I was not inferring it leaked there...
" From my understanding the overall issue is it being too tight, with no room for expansion or contraction, in conjunction with the way its fastened."---------- I don't see any evidence of it being tightly nailed from here.... the angled fastener head is wrong though- it has to move in the slot allotted.
Maybe they just cut the HW flush with the rough opening... the HW keeps the liquid water from the sheathing (imperative) while allowing water vapor to pass through. It should have a continuous bead (except at bottom sill) of caulking/sealant between window/HW/sheathing, on pages 32-35;http://www.google.com/url?sa=t&rct=j...58187178,d.cGU
OR per your HW instructions.
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