Research Problem 1. Charlene and Alton Dutro had lived in their home for two and onehalf years when they decided to enlarge and remodel the house. However, their architect advised them that more stringent building and permit restrictions had been imposed since the house was built 10 years earlier. So the Dutros decided to demolish the house and rebuild on the same site. Rather than occupying the new house, however, the Dutros sold it for a realized gain in excess of $500,000.

In calculating the recognized gain on their Federal income tax return, the Dutros reduced the realized gain of more than $500,000 by the $500,000 exclusion of § 121. The IRS has issued an income tax deficiency notice on the grounds that the Dutros did not satisfy the two-out-of-five-years requirement of § 121(a).
Who is correct?
Partial list of research aids:
§ 121(a)(1).
David A. Gates, 135 T.C. 1 (2010).