Choice "A" is correct. Disregarding any depreciation recapture, Chris and Jennifer have a realized gain of $277,500. For tax purposes, this gain will not be recognized on their Year 6 tax return as it is excludable under the Homeowner's Exclusion. To qualify for the full exclusion of $500,000 for a joint return, the taxpayers must own and use the home as the principal residence for two years out of the five- year period ending on the date of the sale or exchange (and may not have any unqualified use after 2008).Choices "b" and "d" are incorrect. In both these cases, the gain would not be recognized and taxed.
Choice "c" is incorrect. The realized gain is the difference between the taxpayer's basis and the gross proceeds from the sale; not just the gross proceeds.