Totally personal 2 cents worth - start at level 1. The nice thing about AAR is that it's structured to allow you to build in as little or as much repetition as you need, and the repetition can be as targeted as necessary. (For instance, if there's 50 new words in a lesson and she struggled with only one, you keep out the card for that one and put away the other 49). You can move pretty fast if you need to.
What I experienced with my own DD was that she needed almost no repetition, ever. Once she'd seen it, she had it. But until she'd been taught it properly, she did not have it. This became increasingly obvious in later stages of the program when she started to read external material: her errors were almost exclusively in words she had not yet been taught how to handle.
It felt crazy - and crazy-making - to go back to pages and pages of three-letter words. But it was necessary. For one, she had to learn to look at the actual letters in the word, and all of the letters in the word, and all the words in the sentence, not just guess and jump to the big words as she always had. This was painful, let me tell you! But you can't fake context-free lists of three-letter words: you have to look at every single letter and put them together, and that was a painful but essential revelation. And secondly, as noted, she really needed every single phoneme taught properly, not just the more complex ones. She flew through level 1 (it took about a month of after-schooling), and gained both the necessary understanding for the rest of the program, as well as considerable new-found confidence in her ability to learn and read.
