Homesale exclusion. Up to $250,000 of gain ($500,000 for qualifying married taxpayers) from a post-May 6, 1997 homesale is tax-free. As applied to a single taxpayer, the full $250,000 exclusions is available only if the taxpayer:

(1) owned and used the home as a principal residence for periods aggregating two years or more in the five-year period ending on the sale date. (Code Sec. 121(a)), and

(2) did not use the new exclusion for another post-May 6, 1997 principal residence sale. (Code Sec. 121(b)(3)(A)).

IRS applies the 2-out-of-5-year test as follows:

...The taxpayer meets the test if he can show that he owned and lived in the property as his principal residence, or main home, for either 24 full months or 730 days during the 5-year period ending on the sale date. Short temporary absences for vacations and other seasonal absences count as periods of use even if the taxpayer rents out the property during the absences.

..The taxpayer can meet the ownership and use tests separately during different 2-year periods. However, both tests must be met during the 5-year period ending on the sale date.(IRS Pub No. 17 (1997) p. 117).

• The taxpayer owned the principal Aug 5, 1997 (enactment date of 1997 TRA), and sold it after that date but before Aug 5, 1999. (Sec 312(d)(3) of PL 105-34) The taxpayer's reason for selling the home is immaterial.residence on
• The taxpayer fails to meet either of the qualification tests (2-out-of-5-year ownership and use rule, use of the exclusions only once every 2 years) because he had to sell the home due to a change of place of employment, health, or to the extent provided by regs, other unforeseen circumstances. (Code Sec. 121(c)).

Computing the Reduced Exclusion. According to Form 2119 and the worksheet at page 5 of its instructions, the reduced exclusion is computed as follows if a taxpayer is single and has sold only one home after May 6, 1997.

(1) During the 5-year period ending on the sale date, determine the number of days the taxpayer (a) used the home as his principal residence, and (b) owned the home. Enter the smaller of (a) or (b).

(2) Divide the result in (1) by 730 days (i.e., representing two full years of use.

(3) Multiply the result in (2) by $250,000

(4) The taxpayer's homesale exclusion is the lesser of his gain or the result of (3).

The technical clarification indicates that the reduced exclusions is based on the total available exclusion and not on the gain (see illustrated example 2).

In 1990, Sarah was 50 years old and lived in a rented apartment. The apartment building was later converted to a condominium and she bought her apartment on December 1, 1993. In 1995, Sarah became ill and on April 14 of that year, she moved to her daughter's home. On July 10, 1997, while still living in her daughter's home, she sold her apartment because she met the ownership and use tests. her 5-year period is from July 11, 1992 to July 10, 1997, the date of sale. She owned her apartment from December 1, 1993 to July 10, 1997 (over 2 years). She lived in the apartment from July 11, 1992 (the beginning of the 5-year period), to April 14, 1995 (over 2 years). (IRS Pub No. 17 (1997) p.117).

Jones, an unmarried taxpayer, owned and used a home as a principal residence for 365 days before selling it at a $400,000 gain on November 1, 1997. Smith, an unmarried taxpayer, also owned and used a home for 365 days before selling it at a $50,000 gain on November 1, 1997. Neither Jones or Smith owned another home. According to the instructions, Jones can exclude $125,000 of gain (365/730 times $250,000) and Smith can exclude his entire $50,000 profit, since it is less than half of $250,000 (365/730 times $250,000).

Before the technical clarification by the IRS, the reduced exclusion may have been based on the gain (365/730 times $400,000 = $200,000) and not the maximum available exclusion amount.