Everything really happened. Donnie was not insane and he had no mental problems. I assumed this when a) The pills were placebos and b) he saw Frank for real. He had the ability to travel back in time, so he did, and he went back to where he didn't die, and for some reason, everyone woke up. They were all weirded out about something. My idea is that they had the memories of what happened, however, the had them after they woke up, leaving them thinking they were jsut dreams. This is why she recognized Donnie's mother.
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