Deductions & credits

The law on the sale of a home in 1985 was:

You must defer your gain on the sale of your residence if, within the period beginning two years before and ending two years after the sale of your principal residence, you purchase and live in another principal residence whose cost equals or exceeds the adjusted sales price of your old residence.

In such case, you do not have the option of paying or not paying the capital gains tax. The law bars you from paying it.

Instead, you must subtract any gain that is not taxed in the year you sell your old home from the cost of your new home. This gives you a lower basis in the new home. If you have more than one home, you postpone the gain only on the sale of your principal home.

This still holds true.  Publication 523  Selling Your Home  has a worksheet on page 12 Line L: Any gain you postponed from the sale of a previous home sold before May 7, 1997.