To claim the exclusion, you must meet the ownership and use tests. This means that during the 5-year period ending on the date of the sale, you must have:

1. Owned the home for at least 2 years (the ownership test), and
2. Lived in the home as your main home for at least 2 years (the use test).

Exception. If you owned and lived in the property as your main home for less than 2 years, you can still claim an exclusion in some cases. The maximum amount you can exclude will be reduced. See Reduced Maximum Exclusion, earlier.

Example 1 -- met use test but not ownership test. From 1991 through August 1999 Donna lived with her parents in a house that her parents owned. On September 1, 1999, she bought this house from her parents. She continued to live there until December 15, 2000, when she sold it at a gain. Although Donna lived in the property as her main home for more than 2 years, she did not own it for the required 2 years. She cannot exclude any part of her gain on the sale, unless she sold the property due to a change in health or place of employment.

Example 2 -- change in place of employment. Amanda, who is single, bought her first home in August 1998. In December 1999 the company she worked for notified her that she would be transferred to another town in 2000. She continued to live in the home until June 2000, when she sold it at a gain and moved to the new town. Because she owned and lived in the home less than 2 years, she does not meet the ownership and use tests. However, she qualifies to exclude gain because she sold the home due to a change in place of employment. She can use Worksheet 3 to figure the maximum amount of gain she can exclude. It will be less than $250,000.

Period of ownership and use. The required 2 years of ownership and use during the 5-year period ending on the date of the sale do not have to be continuous.

You meet the tests if you can show that you owned and lived in the property as your main home for either 24 full months or 730 days (365 x 2) during the 5-year period ending on the date of sale.

Example. Susan bought and moved into a house in July 1996. She lived there for 13 months and then moved in with a friend. She moved back into her own house in 1999 and lived there for 12 months until she sold it in July 2000. Susan meets the ownership and use tests because, during the 5-year period ending on the date of sale, she owned the house for 4 years and lived in it for a total of 25 months.

Temporary absence. Short temporary absences for vacations or other seasonal absences, even if you rent out the property during the absences, are counted as periods of use.

Example. Professor Paul Beard, who is single, bought and moved into a house on August 30, 1997. He lived in it as his main home continuously until January 5, 1999, when he went abroad for a 1-year sabbatical leave. During part of the period of leave, the house was unoccupied, and during the rest of the period, he rented it out. On January 5, 2000, he sold the house at a gain. Because his leave was not a short temporary absence, he cannot include the period of leave to meet the 2-year use test. He cannot exclude any part of his gain, unless he sold the house due to a change in health or place of employment, as explained under Reduced Maximum Exclusion, earlier. Even if he did sell the house due to a change in health or place of employment, he cannot exclude the part of the gain equal to the depreciation he claimed while renting the house. See Depreciation for business use after May 6, 1997, later.

Ownership and use tests met at different times. You can meet the ownership and use tests during different 2-year periods. However, you must meet both tests during the 5-year period ending on the date of the sale.

Example. In 1991, Helen Jones lived in a rented apartment. The apartment building was later changed to a condominium, and she bought her apartment on December 1, 1997. In 1998, Helen became ill and on April 14 of that year she moved to her daughter's home. On July 10, 2000, while still living in her daughter's home, she sold her apartment.

Helen can exclude gain on the sale of her apartment because she met the ownership and use tests. Her 5-year period is from July 11, 1995, to July 10, 2000, the date she sold the apartment. She owned her apartment from December 1, 1997, to July 10, 2000 (over 2 years). She lived in the apartment from July 11, 1995 (the beginning of the 5-year period), to April 14, 1998 (over 2 years).

Cooperative apartment. If you sold stock in a cooperative housing corporation, the ownership and use tests are met if, during the 5-year period ending on the date of sale, you:

1. Owned the stock for at least 2 years, and
2. Lived in the house or apartment that the stock entitles you to occupy as your main home for at least 2 years.

Exception for individuals with a disability. There is an exception to the use test if, during the 5-year period before the sale of your home:

1. You become physically or mentally unable to care for yourself, and
2. You owned and lived in your home as your main home for a total of at least 1 year.

Under this exception, you are considered to live in your home during any time that you own the home and live in a facility (including a nursing home) that is licensed by a state or political subdivision to care for persons in your condition.

If you meet this exception to the use test, you still have to meet the 2-out-of-5-year ownership test to claim the exclusion.

Gain postponed on sale of previous home. For the ownership and use tests, you may be able to add the time you owned and lived in a previous home to the time you lived in the home on which you wish to exclude gain. You can do this if you postponed all or part of the gain on the sale of the previous home (as described under Rules That Provided for Postponing Gain in chapter 3) because of buying the home on which you wish to exclude gain.

In addition, if buying the previous home enabled you to postpone all or part of the gain on the sale of a home you owned earlier, you can also include the time you owned and lived in that earlier home.

Previous home destroyed or condemned. For the ownership and use tests, you add the time you owned and lived in a previous home that was destroyed or condemned to the time you owned and lived in the home on which you wish to exclude gain. This rule applies if any part of the basis of the home you sold depended on the basis of the destroyed or condemned home. Otherwise, you must have owned and lived in the same home for 2 of the 5 years before the sale to qualify for the exclusion.

Married Persons

If you and your spouse file a joint return for the year of sale, you can exclude gain if either spouse meets the ownership and use tests. (But see Maximum Amount of Exclusion, earlier.)

Example 1 -- one spouse sells a home. Emily sells her home in June 2000. She marries Jamie later in the year. She meets the ownership and use tests, but Jamie does not. Emily can exclude up to $250,000 of gain on a separate or joint return for 2000.

Example 2 -- each spouse sells a home. The facts are the same as in Example 1 except that Jamie also sells a home. He meets the ownership and use tests on his home. Emily and Jamie can each exclude up to $250,000 of gain.

Death of spouse before sale. If your spouse died before the date of sale, you are considered to have owned and lived in the property as your main home during any period of time when your spouse owned and lived in it as a main home.

Home transferred from spouse. If your home was transferred to you by your spouse (or former spouse if the transfer was incident to divorce), you are considered to have owned it during any period of time when your spouse owned it.

Use of home after divorce. You are considered to have used property as your main home during any period when:

1. You owned it, and
2. Your spouse or former spouse is allowed to live in it under a divorce or separation instrument.

Business Use or Rental of Home

You may be able to exclude your gain from the sale of a home that you have used for business or to produce rental income. But you must meet the ownership and use tests.

Example. On May 30, 1994, Amy bought a house. She moved in on that date and lived in it until May 31, 1996, when she moved out of the house and put it up for rent. The house was rented from June 1, 1996, to March 31, 1998. Amy moved back into the house on April 1, 1998, and lived there until she sold it on January 31, 2000. During the 5-year period ending on the date of the sale (February 1, 1995 - January 31, 2000), Amy owned and lived in the house for more than 2 years as shown in the table below.

Five Year Period	Used as Home	Used as Rental
2/1/95 - 5/31/96	16 months
6/1/96 - 3/31/98		22 months
4/1/98 - 1/31/00	22 months
	38 months	22 months

Amy can exclude gain up to $250,000. However, she cannot exclude the part of the gain equal to the depreciation she claimed for renting the house after May 6, 1997, as explained next.

Depreciation for business use after May 6, 1997. If you were entitled to take depreciation deductions because you used your home for business purposes or as rental property, you cannot exclude the part of your gain equal to any depreciation allowed or allowable as a deduction for periods after May 6, 1997. If you can show by adequate records or other evidence that the depreciation deduction allowed was less than the amount allowable, the amount you cannot exclude is the smaller figure.

Example. Micah sold his main home in 2000 at a $30,000 gain. He meets the use and ownership tests to exclude the gain from his income. However, he used part of the home for business in 1999 and claimed $500 depreciation. He can exclude $29,500 ($30,000 - $500) of his gain. He has a taxable gain of $500.

Property used partly as your home and partly for business or rental during the year of sale. In the year of sale you may have used part of your property as your home and part of it for business or to produce income. Examples are:

• A working farm on which your house was located,
• An apartment building in which you lived in one unit and rented out the others,
• A store building with an upstairs apartment in which you lived, or
• A home with a room used for business or to produce income.

If you sell the entire property, you should consider the transaction as the sale of two properties. The sale of the part of your property used for business or rental is reported on Form 4797, Sales of Business Property.

To determine the amounts to report on Form 4797, you must divide your selling price, selling expenses, and basis between the part of the property used for business or rental and the part used as your home. In the same way, if you qualify to exclude any of the gain on the business or rental part of your home, also divide your maximum exclusion between that part of the property and the part used as your home. If you want to use Worksheet 2 to figure your exclusion and taxable gain from each part, fill out a separate Worksheet 2 (Part 2) for each.

Excluding gain on the business or rental part of your home. You generally can exclude gain on the part of your home used for business or rental if you owned and lived in that part of the home for at least 2 years during the 5-year period ending on the date of the sale. If you used a separate Worksheet 2 (Part 2) to figure the exclusion for the business or rental part, do not fill out lines 10 and 11 of that Worksheet 2. Fill it out only through line 9. Then fill out Form 4797. Enter the exclusion for the business or rental part on Form 4797 as explained in the Form 4797 instructions. If you use Part IV of Schedule D (Form 1040) to figure your tax, first fill out the Unrecaptured Section 1250 Gain Worksheet in the Schedule D instructions.

Example. You sold your home on December 1, 2000. You had bought the home in 1990 and had owned and lived in it the entire 5-year period ending on the date of sale. For the first 2 1/2 years of that period, you used the entire house as your main home. For the last 2 1/2 years, you used 3/4 (75%) of the house as your main home and 1/4 (25%) of the house for business. Your records show:

Purchase price	$80,000
Depreciation (on business part; all after 5/7/1997)	1,363
Selling price	160,000
Selling expenses	10,000

Because you meet the ownership and use tests for the entire house, you can claim the exclusion for both the home and business parts. You start by finding the adjusted basis of each part. You determine that three-fourths (75%) of your purchase price was for the part used as your home; one-fourth (25%) was for the part used for business.

	Personal	Business
	(3/4)	(1/4)
Purchase price	$60,000	$20,000
Minus: Depreciation	-0-	1,363
Adjusted basis	$60,000	$18,637

Next, you figure the gain on each part, dividing your selling price and selling expenses between the two parts.

		Personal	Business
		(3/4)	(1/4)
Selling price		$120,000	$40,000
Minus: Selling expenses		7,500	2,500
		$112,500	$37,500
Minus: Adjusted basis		60,000	18,637
	Gain	52,500	18,863

Then, to figure your taxable gain and exclusion on each part, you decide to fill out a separate Worksheet 2 (Part 2) for each part, dividing your maximum exclusion between the two parts. You are single, so your maximum exclusion is $250,000.

		Personal	Business
		(3/4)	(1/4)
Part 2 - Exclusion and Taxable Gain
6)	Depreciation after May 6, 1997	$-0-	$1,363
7)	Subtract line 6 from gain	52,500	$17,500
8)	Maximum exclusion	$187,500	$62,500
9)	Exclusion (Smaller of line 7 or line 8)	52,500	17,500
10)	Taxable gain (gain minus line 9)	-0-	*
11)	Smaller of line 6 or line 10	-0-	*
* Lines 10 and 11 do not need to be filled out for the business part.

The gain from the part used as your home does not have to be reported on your return, because you can exclude all of it. You report the gain from the business part ($18,863) in Part III of Form 4797. You enter your exclusion ($17,500) on line 2 of Form 4797. Your taxable gain from the business part is $1,363 ($18,863 - $17,500).

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