Actually this sentence formulated in this way is rather foolish. So very simply I would translate "la donna vive vicino all'acqua", because "lungo" suggests a direction and the word "acqua" is too general and doesn't include this feature. Also you need to specify what it means "vive" (does she have a house? does she sleep in a bed outdoors?). So specifying the context, perhaps you could say "la donna vive lungo la riva (del fiume/del lago)", "la donna vive lungo la costa", etc.
In my speech community (native English speaker from midwest USA) we would only say "along the river" or maybe "along the shore". We say "near", "by" or "on" the water if it is a lake or pond, (and often for rivers and the shore as well). "Near", "by" and "on" sound natural, and "along" sounds awkward, when followed by "water". But "along" sounds natural enough (but, as you say, rare—it's a class thing) followed by "river".
So it is a class marker and determined by the shape of the water body, either a river or "stretch" of shore. I wouldn't use "along the water" to teach English because "near", "by" and "on" are all more universal and acceptable alternatives. I can accept it as an awkward translation of an Italian phrase, but others here are claiming that it is not well formed Italian so Duo should probably avoid it in future revisions of the tree.
I have family who live along a river. Mostly people say "along", "by", or "on" the water in order to refer to people who live in a house (or other) next to a waterfront. Of course, there's a dozen other ways to say the same thing, so it's really just preference. I have to believe there's a better Italian version of saying this, however...
I pointed that out to Duo in my answer to the other sentence where this came up.... and this is a weird sentence anyway. It would seem more natural to say "lives ON the water," if you're talking about just one person. A village can be "along the water," but one person? Gives rise to strange images....
Yes, "along the coast" sounds better than "along the water", but "along" itself still is strange for one person. Along means "in a line with the length" according to Wiktionary. And one single person cannot be "in a line". A village can be along the coast, because there are many buildings comprising a village. Those buildings can be in a sort of line with the length of the coast.
What a lot of heat about not a lot! In the module I'm doing, this exercise was immediately preceded by 'Il panino è lungo'. DL is clearly showing us different uses of lungo, as an adjective and as a preposition. Maybe if I go along a bit further, I'll also be introduced to lungo as a noun.