3. Rules for Sales Before May 7, 1997

The rules in this chapter are the rules that applied if you sold a main home before May 7, 1997. These rules may still apply to you in some cases. See Who the rules in this chapter apply to, next.

The main topics in this chapter are:

• Rules that allowed you to postpone gain on the sale of a home before May 7, 1997, and
• What you may have to report now if you did postpone gain.

Who the rules in this chapter apply to.   The rules in this chapter still apply to you only if you sold your main home at a gain before May 7, 1997, and all three of the following statements are true.

1. You postponed the gain as described in this chapter.
2. The 2-year period you had to replace that home (your replacement period) was suspended while you either:
   1. Served in the Armed Forces, or
   2. Lived and worked outside the United States.
3. You have not already reported to the IRS either your purchase of a new home within your replacement period or a taxable gain resulting from the end of your replacement period, as described under What To Report Now, later in this chapter.

Gain.   If you had a gain from the sale, you had to include it in your income for the year of sale, except for any part you postponed or excluded.

Loss.   If you had a loss from the sale, you could not deduct it.

Form 2119.   Generally, sales covered by this chapter were reported using Form 2119. If the rules in this chapter apply to you, you may have to file a second Form 2119. See What To Report Now, later in this chapter.

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 51/-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 61/2-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.

If the cost of your new home is

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.

Fixing-up expenses:
Inside and outside painting	$800
Improvements:
New venetian blinds and new water heater	$900

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:

Gain On Sale
a)	Selling price of old home	$71,400
b)	Minus: Selling expenses	5,000
c)	Amount realized on sale		$66,400
d)	Basis of old home	55,000
e)	Plus: Improvements (blinds and heater)	900
f)	Adjusted basis of old home		55,900
g)	Gain on sale [(c) minus (f)]		10,500
Gain Taxed in Year of Sale
h)	Amount realized on sale	66,400
i)	Minus: Fixing-up expenses (painting)	800
j)	Adjusted sales price		65,600
k)	Minus: Cost of new home		64,600
l)	Excess of adjusted sales price over cost of new home		1,000
m)	Gain taxed in year of sale [lesser of (g) or (l)]		1,000
Gain Postponed
n)	Gain on sale [line (g)]	10,500
o)	Minus: Gain taxed [line (m)]	1,000
p)	Gain postponed		9,500
Adjusted Basis of New Home
q)	Cost of new home [line (k)]	64,600
r)	Minus: Gain postponed [line (p)]	$ 9,500
s)	Adjusted basis of new home		$55,100

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.

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