It has been a long-running tax saga for American homeowners, especially those in high-appreciation real estate markets: How do you handle capital gains taxes when you profitably sell your home earlier than the two-year minimum ownership-and-use deadline?

Congress passed the basic tax code changes establishing a streamlined computation system for home sale capital gains in 1997 and 1998. The IRS finally has gotten around to issuing final regulations that tell early sellers how much of their sale profits they can shelter from the federal capital gains bite -- if indeed they get to shelter anything.

The regulations, which took effect Aug. 13, are different in subtle ways from the interim regulations that have governed for the past few years. For taxpayers who aren't sure how they are affected, reading the new rules could be worthwhile.

The regulations essentially deal with exceptions to the $500,000 and $250,000 tax-free exclusion provisions of the 1997 and 1998 statutes. Those laws allow married, joint-filing home sellers to pocket up to $500,000 in sale profits ($250,000 for single filers) tax-free, provided that they owned and used the house as their principal residence for an aggregate two years out of the five years preceding the sale of the property.

The laws also provide exceptions for certain homeowners who, for reasons of health, employment change or "unforeseen circumstances," sell their homes before they were able to meet the two-year minimum holding standard. For those who qualify, a "reduced maximum" capital gains tax exclusion is available, based on the amount of time they owned and used the house.

For example, a couple who bought a house and had to sell it just 18 months later because of an unexpected cross-country employment transfer might be able to take up to three-fourths of the maximum $500,000 tax-free exclusion. A single owner who had to sell after a year of ownership because of an incapacitating, unexpected illness might qualify for half of the standard $250,000 maximum.

But what about what Congress called "unforeseen circumstances"? When can they be used by home sellers to justify a sale before the two-year deadline, potentially saving thousands of dollars in capital gains taxes?

The IRS's new rules provide some no-nonsense answers. To begin, you cannot claim that you experienced an "unforeseen," overwhelming desire to own a different house in a different neighborhood and expect to get an exception to the two-year ownership-and-use rule. Forget it.

Ditto for winning the lottery; just because you're suddenly flush with cash and have a wider range of houses to choose from won't be enough to qualify for an "unforeseen" exception to the standard set by the law. The same goes for sudden marriages, which some taxpayers have argued truly fall into the category of unforeseen events. (Only in Las Vegas, perhaps?)

What does qualify as unforeseen, according to the new rules, are events "that the taxpayer could not reasonably have anticipated" at the time of purchasing the house. To wit:

* The "involuntary conversion" of your home; for example, when the state government requires you to sell your house to make way for a highway.

* Natural or man-made disasters or acts of war or terror that damage the residence.

* The death of the homeowner, a spouse, co-owner or other person whose principal place of residence is the house that was sold.

* A loss of employment triggering eligibility for unemployment compensation.

* A change in employment status that results in the owner's inability to pay housing costs and reasonable basic living expenses for the household.

* Divorce or legal separation.

* Multiple births resulting from the same pregnancy.

That pretty much exhausts the IRS's qualifying list of "unforeseen" precipitating events for a home sale. However, the final rules do allow taxpayers to make their case on a "facts and circumstances" basis. Good luck.

On claims of health reasons precipitating early sales, the rules require that the "primary reason" for the sale must be "to obtain, provide or facilitate the diagnosis, cure, mitigation or treatment of disease, illness or injury" of the homeowner, co-owner, spouse or other resident. But if you sell early just because you think you might feel better living somewhere else, the IRS is not likely to be sympathetic: A "sale . . . that is merely beneficial to the general health or well-being of an individual" won't qualify for the tax break, says the agency.

The final rules also incorporate important changes to the home sale capital gains law mandated by the Military Family Tax Relief Act of 2003. Members of the armed forces or the Foreign Service who are posted abroad for extended periods now will be permitted to stop the two-out-of-five-year clock when they leave the country. That, in turn, should help avoid situations in which military and Foreign Service personnel confront big tax bills on home sales because they weren't occupants for long enough during the preceding five years.

The final regulations are outlined in IRS document TD 9152, available on the Internet at

Kenneth R. Harney's e-mail address is