Rules That Provided for Postponing Gain

Under the rules of this chapter, you were required to postpone tax on the gain on the sale of your main home before May 7, 1997, if both of the following were true.

1. You bought and lived in a new main home before the end of the replacement period.
2. The new main home cost at least as much as the adjusted sales price of the old home.

Also, if you were age 55 or older on the date of sale and met certain other qualifications, no tax applied to any gain you chose to exclude (on line 14 of Form 2119).

This section of the chapter explains the time allowed for replacing your main home (the replacement period) and how to determine the taxable gain, if any. The main topics in this section are:

• Replacement period,
• Old home,
• New home, and
• Certain sales by married persons.

Tax postponed, not forgiven. The tax on the gain is postponed, not forgiven. You subtract any gain that is not taxed in the year you sell your old home from the cost of your new home. This gives you a lower basis in the new home.

Example. You sold your home in February 1997 for $90,000 and had a $5,000 gain. In January 1999, within the time allowed for replacement, you bought another home for $103,000 and moved into it. The $5,000 gain was not taxed in 1997, but you must subtract it from the $103,000. This makes the basis of your new home $98,000. If you later sell the new home for $110,000, your gain will be $12,000 ($110,000 - $98,000).

Source of funds to buy home. You do not have to use the same funds received from the sale of your old home to buy or build your new home. For example, you can use less cash than you received by increasing the amount of your mortgage loan and still postpone the tax on your gain.

Replacement Period

Your replacement period is the time period during which you must replace your old home to postpone any of the gain from its sale. It started 2 years before and ends 2 years after the date of sale.

Example. You sold your old home on April 27, 1997. You had until April 27, 1999, to buy and move into a new home that you use as your main home.

Suspension of replacement period. The 2-year replacement period after the sale may be suspended only for the following individuals.

1. People living and working outside the United States.
2. Members of the Armed Forces.

If you are one of these individuals and sold a home before May 7, 1997, your replacement period may include all or part of 2001. For everyone else who sold a home before May 7, 1997, the replacement period ended before 2000.

The following chart illustrates the replacement period for most people and for those who qualify for the suspension. The chart uses the example of a home sold on April 30, 1997.

Replacement period

Home not replaced within replacement period. If you do not replace the home in time and you had postponed gain in the year of sale, you must file an amended return for the year of sale. You must include in your income the entire gain on the sale of your old home. For details, see What To Report Now, later in this chapter.

Occupancy test. You must physically live in the new home as your main home within the replacement period. If you move furniture or other personal belongings into the new home but do not actually live in it, you have not met the occupancy test.

No added time is allowed. To postpone gain on the sale of your home, you must replace the old home and occupy the new home within the specified period. You are not allowed any additional time, even if conditions beyond your control keep you from doing it. For example, destruction of the new home while it was being built would not extend the replacement period.

People Outside the United States

The replacement period after the sale of your old home is suspended while you have your tax home (the place where you live and work) outside the United States. This suspension applies only if your stay abroad begins before the end of the 2-year replacement period. The replacement period, plus the period of suspension, is limited to 4 years after the date of sale of your old home.

Example. You sold your home on April 11, 1997. This began your replacement period. On August 11, 1997, you were transferred to a foreign country. You had used 4 months of your replacement period and had 20 months left. From August 11, 1997, to May 10, 1999, when you returned to the United States, your replacement period was suspended. Your replacement period started again on May 11, 1999, and ends 20 months later on January 11, 2001.

Married persons. If you are married, the suspension of the replacement period lasts while either you or your spouse has a tax home outside the United States, provided both of you used the old and the new homes as your main home.

Tax home. Your tax home is the city or general area of your main place of business, employment, station, or post of duty. For your tax home to be outside the United States, you must live and work there. It does not matter where your family lives. More information on a tax home outside the United States is in Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad.

Combat zone service. The running of the replacement period (including the suspension if you live and work outside the United States) is suspended for any period you served in a combat zone in support of the Armed Forces, plus 180 days. This suspension applies even though you were not a member of the Armed Forces. It applies to Red Cross personnel, accredited correspondents, and civilians under the direction of the Armed Forces in support of those forces.

The rules for suspending the running of the replacement period and for applying that suspension to your spouse are the same as the suspension rules explained later under Members of the Armed Forces and its discussion Combat zone service.

Members of the Armed Forces

The replacement period after the sale of your old home is suspended while you serve on extended active duty in the Armed Forces. You are on extended active duty if you are serving under a call or order for more than 90 days or for an indefinite period. The suspension applies only if your service begins before the end of the 2-year replacement period. The replacement period, plus any period of suspension, is limited to 4 years after the date you sold your old home.

Example 1. You sold your home on March 1, 1997. This began your replacement period. You joined the Armed Forces on June 1, 1997. You had used 3 months of your replacement period (March, April, and May). Your active duty ended May 31, 1999. From June 1, 1997, to May 31, 1999, your replacement period was suspended. Your replacement period started again on June 1, 1999, and you have until March 1, 2001 (21 months) to buy or build and live in your new home.

Example 2. You are a regular member of the Armed Forces and sold your home on April 4, 1997. If you remain in the Armed Forces, you postpone your gain from the sale of your old home only if you buy or build and live in another home by April 4, 2001.

Overseas assignment. The suspension of the replacement period after the sale of your old home is extended for up to an additional 4 years while you are:

• Stationed outside the United States, or
• Required to live in on-base quarters following your return from a tour of duty outside the United States. In this case, you must be stationed at a remote site where the Secretary of Defense has determined that adequate off-base housing is not available.

The suspension can continue for up to 1 year after the last day you are stationed outside the United States or the last day you are required to live in government quarters on base. However, the replacement period, plus any period of suspension, is limited to 8 years after the date of sale of your old home.

Example 1. You are a regular member of the Armed Forces and sold your home on May 1, 1995. During the 4 years from May 1, 1995, to May 1, 1999, you served outside the United States. When you returned, you were stationed at a remote site and were required to live on base because off-base housing was not available. The time to replace your home was suspended:

1. While you were serving outside the United States, plus
2. While you were required to live on base after your return from the overseas assignment, plus
3. Up to 1 year.

The requirement that you live on base ended on October 31, 1999, so the suspension period expired October 31, 2000. You still have the full 2-year replacement period to buy or build and occupy a new home. This is because you did not use any of that time before your overseas assignment began, and your replacement period plus your 5 1/2-year period of suspension is not more than 8 years. Your replacement period ends on October 31, 2002.

Example 2. The facts are the same as in Example 1 except the requirement that you live on base ended on October 31, 2000. The suspension period expired October 31, 2001. You have less than the full 2-year replacement period to buy or build and occupy a new home. This is because your replacement period plus your 6 1/2-year period of suspension is limited to 8 years after the sale of your old home. Therefore, your replacement period ends on May 1, 2003.

Spouse in Armed Forces. If your spouse is in the Armed Forces and you are not, the suspension also applies to you if you owned the old home. Both of you must have used the old home and must use the new home as your main home. However, if you are divorced or separated while the replacement period is suspended, the suspension ends for you on the date of the divorce or separation.

Combat zone service. The running of the replacement period (including any suspension) is suspended for any period you served in a combat zone.

Combat zone. The term "combat zone" means:

1. The Persian Gulf Area combat zone (effective August 2, 1990),
2. The qualified hazardous duty area of Bosnia and Herzegovina, Croatia, and Macedonia, which is treated as a combat zone effective November 21, 1995, and
3. The Federal Republic of Yugoslavia (Serbia/Montenegro), Albania, the Adriatic Sea, and the Ionian Sea north of the 39th parallel, effective March 24, 1999.

Service outside combat zone. If you performed military service in an area outside the combat zone that was in direct support of military operations in the combat zone and you received special pay for duty subject to hostile fire or imminent danger, you are treated as if you served in the combat zone.

Also, you are treated as if you served in a combat zone if you performed services as part of Operation Joint Endeavor, Operation Joint Guard, or Operation Allied Force, were outside the United States, and were deployed away from your permanent duty station.

When suspension ends. This suspension ends 180 days after the later of:

1. The last day you were in the combat zone (or, if earlier, the last day the area qualified as a combat zone), or
2. The last day of any continuous hospitalization (limited to 5 years if hospitalized in the United States) for an injury sustained while serving in the combat zone.

Example. Sergeant James Smith, on extended active duty in an Army unit stationed in Virginia, had a gain from the sale of his home on June 4, 1996. He had not yet purchased a new home when he entered a combat zone on January 4, 1997. He left the combat zone on January 4, 1998, and returned with his unit to Virginia. He remains on active duty in Virginia.

Sergeant Smith's replacement period began on June 4, 1996, the date he sold the home. If he had not been sent to a combat zone, his replacement period would have ended 4 years later, on June 4, 2000.

When he entered the combat zone on January 4, 1997, Sergeant Smith had used 7 months of the replacement period. The replacement period was then suspended for the time he served in the combat zone plus 180 days. The replacement period started again on July 4, 1998, after the end of the 180-day period (January 5, 1998, to July 3, 1998) following his last day in the combat zone. Sergeant Smith then has 41 months remaining in his replacement period (4 years minus the 7 months already used). His replacement period ends December 3, 2001 (41 months after July 3, 1998).

Spouse. The suspension for service in a combat zone generally applies to your spouse (even if you file separate returns). However, any suspension because of your hospitalization within the United States does not apply to your spouse. Also, the suspension for your spouse does not apply for any tax year beginning more than 2 years after the last day the area qualified as a combat zone.

More information. For information on other tax benefits available to those who served in a combat zone, get Publication 3, Armed Forces' Tax Guide.

Old Home

To figure the taxable gain and postponed gain from the sale of your old home, compare the adjusted sales price of your old home with the cost of your new home, as shown in the following chart.

Adjusted sales price. This is the amount realized from the sale of your old home minus:

• Any one-time exclusion you claimed (line 14 of Form 2119), and
• Any fixing-up expenses you had ( line 16 of Form 2119).

If the amount realized (minus any one-time exclusion) is not more than the cost of your new home, you postpone your entire gain. You do not need to figure your fixing-up expenses.

Fixing-up expenses. Fixing-up expenses are decorating and repair costs that you paid to sell your old home. For example, the costs of painting the home, planting flowers, and replacing broken windows are fixing-up expenses. Fixing-up expenses must meet all the following conditions. The expenses:

1. Must be for work done during the 90-day period ending on the day you sign the contract of sale with the buyer,
2. Must be paid no later than 30 days after the date of sale,
3. Cannot be deductible in arriving at your taxable income,
4. Must not be used in figuring the amount realized, and
5. Must not be capital expenditures or improvements.

Note. You subtract fixing-up expenses from the amount realized only in figuring the part of the gain that you postpone. You cannot use them in figuring the actual gain on the sale.

Example. Your old home had a basis of $55,000. You signed a contract to sell it on December 17, 1996. On January 7, 1997, you sold it for $71,400. Selling expenses were $5,000. During the 90-day period ending December 17, 1996, you had the following work done. You paid for the work within 30 days after the date of sale.

Within the replacement period, you bought and lived in a new home that cost $64,600. You figure the gain postponed and not postponed, and the basis of your new home, as follows:

Property used partly as your home and partly for business or rental. You may use part of your property as your home and part of it for business or to produce income. If you sell the entire property, you should consider the transaction as the sale of two properties. You postpone the gain only on the part used as your home. This includes the land and outbuildings, such as a garage for the home, but not those used for the business or the production of income.

To postpone the gain on the part of the property that is your home (one property), you must reinvest an amount equal to that part's adjusted sales price in your new home. The same rule applies if you buy property for use as your home and for your business. Only the purchase price for the part used as your home can be counted as the cost of a new home. See New home used partly for business or rental, later.

For an example of how to divide the gain between the part of the property used as your home and the part used for business or other purposes, see Business Use or Rental of Home in chapter 2.

Home changed to rental property. You cannot postpone tax on the gain on rental property, even if you once used it as your home. The rules explained in this chapter generally will not apply to its sale. Gains are taxable and losses are deductible as explained in Publication 544.

Temporary rental of home before sale. You have not changed your home to rental property if you temporarily rented your old home before selling it, or your new home before living in it, as a matter of convenience or for another nonbusiness purpose. You postpone the tax on the gain from the sale if you meet the requirements explained earlier.

For information on how to treat the rental income you receive, see Publication 527.

Failed attempt to rent home. If you placed your home with a real estate agent for rent or sale and it was not rented, it is not considered business property or property held for the production of income. The postponement of gain rules explained in this chapter will apply to the sale.

New Home

Your new home must be your main home. See the explanation of "main home" in chapter 1.

You must include in income any gain from the sale of your old home if you replace it with property that is not your main home.

New home outside the United States. A new home outside the United States qualifies as a new home for purposes of postponing gain. You must buy or build and live in the new home as your main home within the time allowed for replacement.

Retirement home. You have not purchased a new home if you invest in a retirement home project that gives you living quarters and personal care but does not give you any legal interest in the property. Therefore, you must include in income any gain on the sale of your old home. However, if you were age 55 or older on the date of the sale, you may have been able to claim a one-time exclusion (line 14 of Form 2119).

Title to new home not held by you or spouse. You have not purchased a new home if you invest in a home in which neither you nor your spouse holds any legal interest (for example, a house to which someone else, such as your child, holds the title).

Holding period. If you postponed tax on any part of the gain from the sale of your old home, you will be considered to have owned your new home for the combined period you owned both the old and the new homes. This may affect how any taxable gain when you sell the new home is reported on Schedule D (Form 1040).

How To Figure Cost of New Home

You need to know the cost of your new home to figure the gain taxed and the gain on which tax is postponed on the sale of your old home. The cost of your new home includes costs incurred during the replacement period for the following items:

1. Buying or building the home,
2. Rebuilding the home, and
3. Capital additions or improvements.

You cannot consider any costs incurred before or after the replacement period. However, if you live outside of the United States or are a member of the Armed Forces, you can include any costs incurred during the suspension period (discussed under Replacement Period, earlier).

Debts on new home. The cost of a new home includes the debts it is subject to when you buy it (purchase-money mortgage or deed of trust) and the face amount of notes or other liabilities you give for it.

Temporary housing. If a builder gives you temporary housing while your new home is being finished, you must reduce the contract price to arrive at the cost of the new home. To figure the amount of the reduction, multiply the contract price by a fraction. The numerator is the value of the temporary housing, and the denominator is the sum of the value of the temporary housing plus the value of the new home.

Seller-paid points. In figuring the cost of your new home, you must subtract any points paid by the seller from your purchase price.

Settlement fees or closing costs. The cost of your new home includes the settlement fees and closing costs that you can include in your basis. See Settlement fees or closing costs under Basis, in chapter 2.

Settlement fees do not include amounts placed in escrow for the future payment of items such as taxes and insurance.

Real estate taxes. If you agreed to pay taxes the seller owed on your new home (that is, taxes up to the date of sale), the taxes you paid are treated as part of the cost. For more information, see Real Estate and Transfer Taxes in chapter 2.

New home used partly for business or rental. If you replace your old home with property used partly as your home and partly for business or rental, you consider only the cost of the part used as your home. You must compare the cost of this part to the adjusted sales price of the old home to determine the amount of gain taxed in the year of sale and the amount of gain on which tax is postponed.

Example. Your old home had a basis of $50,000. You sold it in February 1997 for a gain of $25,000. Your adjusted sales price is $75,000. Before your replacement period ended, you bought a duplex house for $120,000. You live in half and rent the other half. Because only half of the cost of the duplex ($60,000) is considered an investment in a new main home, you are taxed on $15,000 ($75,000 adjusted sales price - $60,000 cost) of the $25,000 gain on the sale. You must postpone tax on $10,000 of the gain reinvested in your new home. The basis of your new home is $50,000 ($60,000 cost - $10,000 postponed gain). The basis of the rented part of the duplex is $60,000.

Inheritance or gift. If you receive any part of your new home as a gift or an inheritance, you cannot include the value of that part in the cost of the new home when figuring the gain taxed in the year of sale and the gain on which tax is postponed. However, you include the basis of that part in your adjusted basis to determine any gain when you sell the new home.

Example. You bought a home in 1992 for $60,000. You sold that home in March 1997 for $65,000, at a gain of $5,000. You had fixing-up expenses of $200.

Later, your father died and you inherited his home. Its basis to you is $62,000. You spent $14,000 to modernize the home, resulting in an adjusted basis to you of $76,000. You moved into the home before your replacement period ended.

To find the gain taxed in the year of the sale, you compare the adjusted sales price of the old home, $64,800 ($65,000 - $200), with the $14,000 you invested in your new home. (For this purpose, you do not include the value of the inherited part of your property, $62,000, in the cost of your new home.) The $5,000 gain is fully taxed because the adjusted sales price of the old home is more than the amount you paid to remodel your new home, and the difference between the two amounts is more than $5,000.

Certain Sales by Married Persons

This section explains how married persons figure their postponed gain in certain situations.

Home owned separately by one spouse. You may be able to postpone gain from the sale of your old home even if:

• You or your spouse owned the old home separately, but title to the new one is in both your names as joint tenants, or
• You and your spouse owned the old home as joint tenants, and either you or your spouse owns the new home separately.

You and your spouse can figure the postponed gain, which reduces the basis of the new home, as if the two of you owned both homes jointly. To do this, both of you must meet both of the following requirements.

• You used the old home as your main home and you use the new home as your main home.
• You sign a statement that says: "We agree to reduce the basis of the new home by the gain from selling the old home."

Both of you must sign the statement. You can make the statement in the bottom margin on page 1 of Form 2119 or on an attached sheet. If either of you does not sign the statement, you must report the gain in the regular way, as explained in the following example.

Example. In April 1997, you sold a home that you owned separately but that both you and your spouse used as your main home. The adjusted sales price was $98,000, the adjusted basis was $86,000, and the gain on the sale was $12,000. Before the replacement period ends, you and your spouse buy a new home for $100,000. You move in immediately. The title is held jointly, and under state law, you each have a one-half interest. If you both sign the statement to reduce the basis of the new home, you postpone the gain on the sale as if you had owned both the old and new homes jointly. You and your spouse will each have an adjusted basis of $44,000 ($50,000 cost minus $6,000 postponed gain) in the new home.

If either of you does not sign the statement, your entire gain of $12,000 will be currently taxed, not postponed. This is because the adjusted sales price of the old home ($98,000) is greater than your part of the cost of the new home ($50,000). You and your spouse will each have a basis of $50,000 in the new home.

Deceased spouse. If your spouse dies after you sell your old home and before you buy and occupy a new home, you can postpone the gain from the sale of the old home if the basic requirements are met, and:

1. You were married on the date your spouse died, and
2. You use the new home as your main home.

This applies whether title to the old home is in one spouse's name or held jointly.

Separate homes replaced by single home. If you and your spouse both had gains from the sales of homes that had been your separate main homes before your marriage, you may have to postpone the tax on both gains. This can happen if all of the following are true.

• You jointly purchase a new home.
• Each spouse's share of the cost of the new home is at least as much as the adjusted selling price of that spouse's old home. (Each spouse's share of the cost of the new home is the part equal to his or her interest in the home under state law, generally one-half.)
• Each spouse occupies the new home within the replacement period.

Home replaced by two homes of spouses living apart. If you and your spouse sell a jointly-owned home and each of you then buys and lives in separate new homes, the postponement provisions apply separately to your gain and to your spouse's gain.

You report the sale of your home as if two separate properties were sold. You each report half of the sales price.

Only one spouse buys a new home. Even if your spouse does not buy a new home within the replacement period, you still should report only your share of any gain from the sale of the old home. You postpone your share of the gain if you meet all the requirements to do so, even though your spouse cannot postpone his or her share.

If you and your spouse originally filed a joint return for the year of sale, you and your spouse must file an amended joint return to report your spouse's share of the gain, which cannot be postponed. See Divorce after sale, under What To Report Now, later in this chapter.

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