Driveline lash and clunk are controlled in a powertrain system having multiple torque-generative and torque control devices using a multivariable feedback control approach to provide active driveline damping. Control parameters used by a state estimator are different, depending on whether the driveline lash is taken up or is currently slack. When the estimated driveline axle torque is not substantially zero, the nominal parameters for transmission mode or gear are used in the state estimator. When the estimated axle torque is substantially zero, the parameters are switched to neutral parameters, the lash estimator indicates neutral lash state, and angle of lash is tracked until it accumulates an expected amount of lash in the driveline. During a lash transition time, active damping controls the driveline component speeds so that the effect of lash take-up is minimized. After lash take-up occurs, desired axle torque is used by the system.