You may qualify to exclude from your income all or part of any gain from the sale of your main home. This means that, if you qualify, you will not have to pay tax on the gain up to the limit described under Maximum Amount of Exclusion, next. To qualify, you must meet the ownership and use tests described later.

You can choose not to take the exclusion. In that case, you must include in income your entire gain.

Maximum Amount of Exclusion

You can exclude the entire gain on the sale of your main home up to:

1. $250,000, or
2. $500,000 if all of the following are true.
   1. You are married and file a joint return for the year.
   2. Either you or your spouse meets the ownership test.
   3. Both you and your spouse meet the use test.
   4. During the 2-year period ending on the date of the sale, neither you nor your spouse excluded gain from the sale of another home.

Reduced Maximum Exclusion

You can claim an exclusion, but the maximum amount of gain you can exclude will be reduced, if either of the following is true.

1. You did not meet the ownership and use tests, but you sold the home due to:
   1. A change in place of employment,
   2. Health, or
   3. Unforeseen circumstances, to the extent provided in regulations (as discussed later).
2. Your exclusion would have been disallowed because of the rule described in More Than One Home Sold During 2-Year Period, later, except that you sold the home due to:
   1. A change in place of employment,
   2. Health, or
   3. Unforeseen circumstances, to the extent provided in regulations (as discussed next).

Use Worksheet 3 in Publication 523 to figure your reduced maximum exclusion.

Unforeseen circumstances. The IRS has not issued regulations defining unforeseen circumstances. You cannot claim an exclusion based on unforeseen circumstances until the IRS issues final regulations or other appropriate guidance.

More Than One Home Sold During 2-Year Period

You cannot exclude gain on the sale of your home if, during the 2-year period ending on the date of the sale, you sold another home at a gain and excluded all or part of that gain. If you cannot exclude the gain, you must include it in your income.

However, you can still claim an exclusion if you sold the home due to:

1. A change in place of employment,
2. Health, or
3. Unforeseen circumstances, to the extent provided in regulations (as discussed earlier).

The maximum amount you can exclude is reduced. See Reduced Maximum Exclusion, earlier.

Ownership and Use Tests

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 claim will be reduced. See Reduced Maximum Exclusion, earlier.

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 × 2) during the 5-year period ending on the date of sale.

Temporary absence. Short temporary absences for vacations or other seasonal absences, even if you rent the property during the absences, are counted as periods of use. See Ownership and use tests met at different times, later.

Example. Professor Paul Beard, who is single, bought and moved into a house on August 28, 1998. He lived in it as his main home continuously until January 5, 2000, 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. On January 5, 2001, 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 place of employment or health, as explained under Reduced Maximum Exclusion, earlier. Even if he did sell the house due to a change in place of employment or health, 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 1992, Helen Jones lived in a rented apartment. The apartment building was later changed to a condominium, and she bought her apartment on December 1, 1998. In 1999, Helen became ill and on April 14 of that year she moved to her daughter's home. On July 10, 2001, 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, 1996, to July 10, 2001, the date she sold the apartment. She owned her apartment from December 1, 1998, to July 10, 2001 (over 2 years). She lived in the apartment from July 11, 1996 (the beginning of the 5-year period), to April 14, 1999 (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 because of buying the home on which you wish to exclude gain.

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 2001. She marries Jamie later in the year. She meets the ownership and use tests, but Jamie does not. She can exclude up to $250,000 of gain on a separate or joint return for 2001.

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 1. On May 30, 1995, Amy bought a house. She moved in on that date and lived in it until May 31, 1997, when she moved out of the house and put it up for rent. The house was rented from June 1, 1997, to March 31, 1999. Amy moved back into the house on April 1, 1999, and lived there until she sold it on January 31, 2001. During the 5-year period ending on the date of the sale (February 1, 1996 - January 31, 2001), 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
2/1/96 - 5/31/97	16 months
6/1/97 - 3/31/99		22 months
4/1/99 - 1/31/01	22 months
	38 months	22 months

Amy can exclude gain up to $250,000. But she cannot exclude the part of the gain equal to the depreciation she claimed for renting the house, as explained after Example 2.

Example 2. William owned and used a house as his main home from 1995 through 1998. On January 1, 1999, he moved to another state. He rented his house from that date until April 30, 2001, when he sold it. During the 5-year period ending on the date of sale (May 1, 1996 - April 30, 2001), William owned and lived in the house for 32 months (more than 2 years). He can exclude gain up to $250,000. However, he cannot exclude the part of the gain equal to the depreciation he claimed for renting the house, 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. Ray sold his main home in 2001 at a $30,000 gain. He meets the ownership and use tests to exclude the gain from his income. However, he used part of the home for business in 2000 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 (home office) 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. For more information, see Property used partly as your home and partly for business or rental during the year of sale under Business Use or Rental of Home in chapter 2 of Publication 523.

Special Situations

The situations that follow may affect your exclusion.

Expatriates. You cannot claim the exclusion if the expatriation tax applies to you. The expatriation tax applies to U.S. citizens who have renounced their citizenship (and long-term residents who have ended their residency) if one of their principal purposes was to avoid U.S. taxes. See chapter 4 of Publication 519, U.S. Tax Guide for Aliens, for more information about expatriation tax.

Home destroyed or condemned. If your home was destroyed or condemned, any gain (for example, because of insurance proceeds you received) qualifies for the exclusion.

Any part of the gain that cannot be excluded (because it is more than the limit) may be postponed under the rules explained in:

• Publication 547, Casualties, Disasters, and Thefts, in the case of a home that was destroyed, or
• Chapter 1 of Publication 544, Sales and Other Dispositions of Assets, in the case of a home that was condemned.

Sale of remainder interest. Subject to the other rules in this chapter, you can choose to exclude gain from the sale of a remainder interest in your home. If you make this choice, you cannot choose to exclude gain from your sale of any other interest in the home that you sell separately.

Exception for sales to related persons. You cannot exclude gain from the sale of a remainder interest in your home to a related person. Related persons include your brothers and sisters, half-brothers and half-sisters, spouse, ancestors (parents, grandparents, etc.), and lineal descendants (children, grandchildren, etc.). Related persons also include certain corporations, partnerships, trusts, and exempt organizations.

Reporting the Gain

Do not report the 2001 sale of your main home on your tax return unless:

• You have a gain and you do not qualify to exclude all of it, or
• You have a gain and you choose not to exclude it.

If you have any taxable gain on the sale of your main home that cannot be excluded, report the entire gain realized on Schedule D (Form 1040). Report it on line 1 or line 8 of Schedule D, depending on how long you owned the home. If you qualify for an exclusion, show it on the line directly below the line on which you report the gain. Write "Section 121 exclusion" in column (a) of that line and show the amount of the exclusion in column (f) as a loss (in parentheses).

If you used the home for business or to produce rental income during the year of sale, you must use Form 4797 to report the sale of the business or rental part (or the sale of the entire property if used entirely for business or rental in that year). See Business Use or Rental of Home in chapter 2 of Publication 523.

Installment sale. Some sales are made under arrangements that provide for part or all of the selling price to be paid in a later year. These sales are called "installment sales." If you finance the buyer's purchase of your home yourself, instead of having the buyer get a loan or mortgage from a bank, you probably have an installment sale. You may be able to report the part of the gain you cannot exclude on the installment basis.

Use Form 6252, Installment Sale Income, to report the sale. Enter your exclusion on line 15 of Form 6252.

Seller-financed mortgage. If you sell your home and hold a note, mortgage, or other financial agreement, the payments you receive generally consist of both interest and principal. You must report the interest you receive as part of each payment separately as interest income. If the buyer of your home uses the property as a main or second home, you must also report the name, address, and social security number (SSN) of the buyer on line 1 of either Schedule B (Form 1040) or Schedule 1 (Form 1040A). The buyer must give you his or her SSN and you must give the buyer your SSN. Failure to meet these requirements may result in a $50 penalty for each failure. If you or the buyer does not have and is not eligible to get an SSN, see Social Security Number in chapter 1.

More information. For more information on installment sales, see Publication 537, Installment Sales.

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