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Warning, stream of conciousness post. Some tax problems are interesting intellectual exercises, and this seems to be one. I've changed my mind several times while writing it. However, if I paused to get my thoughts straight, evil AOL would kick me off.

Crosenfield:If I'm wrong someone will correct...

You're wrong. You can pro-rate the exemption based on the fraction out of 365 x 2 = 730 days you have lived there, provided there is a good reason. A job-related move is one good reason. We had a discussion about this a while back, and the question arose as to whether moving to take a new job was good enough, as opposed to being transferred by the same employer. I guessed no, but the consensus was yes. So let's say Yes is correct.

The question I had while composing a reply, was When did Trexfool sell House #2? If it was in 2000, then he has until April 15 to make a decision. If it was in 1999 or earlier, he is going to have to file a 1040X, and maybe come up with some big late taxes, penalties, and interest. Since Trexfool is vague on times, we don't know.

Assuming Trexfool did sell in 2000, the question arises as to how long he can wait. I think the financially best thing is the following. But then, I'm not a lawyer or a CPA, and I don't even play one on TV, and this is one I would certainly go to a professional for advice on.

I think the pro-ration on House #2 is not much, and by taking it he would effectively preclude himself from taking the pro-rated exemption on House #1[*]. That's because of the two year timeout period between taking exclusions. It's been 4 years and 3 months (roughly) since he bought House #1, so his exclusion, even if pro-rated, starts self-destructing in 9 months.

So, if Trexfool bites the bullet and pays the tax on his gain on House #2 on April 15, then he has at least 9 months to see how House #1, which he has not sold, appreciates. Then, his problem is to decide whether any additional gain outweighs the diminution of the exclusion if he waits beyond those 9 months.

[*] Except as I write this I now suppose that the 2 year clock starts ticking on the date of sale of House #2, not on April 15, 2001. That makes the second exclusion possible in maybe a year, so the lost exclusion on House #1 might not be all that much.
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