Should windows be sealed from the outside before the capping is done

That sounds like it would work but its involved. I do what you do and use the double stick tape on the flat top of the sill. Then before I shrink the plastic I get normal clear packaging tape and go around the whole window again. I get a lot of draft and condensation and over the years this technique evolved and seems to work.

Unfortunately, the windows probably should have been addressed before the new siding went on. Doing the windows before putting on new siding would have given you the option of using new construction vinyl double hung with J-channel build into the frames. It also would make repairing or replacing rotted framing members much easier.

However, since you already have the new siding up (would like to see a pic of the window with the new siding in place) you may have to use replacement type windows. If you have rotted frames, those will have to be replaced and the new replacement windows sized to the opening AFTER the frame is fixed. Of course you can carefully calculate the opening based on what you intend to use to reframe the opening, but that can be risky for an amateur. Keep in mind, replacement windows usually have to be ordered to you exact size and are not returnable if you measure them wrong. Always a good move to have supplier measure and order the windows for you. After you install the new replacement windows, you may have to install some new extension jams and exterior trim in order to fit snugly to the new siding. Don't forget to use Ice & Water shield under the finish frame/ over rough opening framing and caulk all areas where water could possibly get in.