Yes, a new cost basis will apply for the new replacement home if you use Sec. 121. Yes, you must meet the period of ownership (two years) to claim Sec. 121 again.
IRS Pub. 544, page 6 explains an involuntary conversion occurs when your property is destroyed, stolen, condemned, or disposed of under the threat of condemnation and you receive other property or money in payment, such as insurance or a condemnation award. A gain or loss from an involuntary conversion of your property is usually recognized for tax purposes unless the property is your main home.
Sec. 121 allows individuals to exclude a gain of up to $250,000 ($500,000 if married filing a joint return) from their gross income on the sale or exchange of their principal residence. If the taxpayer excludes a gain under Sec 121, the taxpayer does not adjust the basis of any new home acquired due to the exclusion. To use the exclusion, the taxpayer must have owned the home and used it as a principal residence for a period of, or periods totaling, two years or more within the five years before the sale or exchange. The periods of ownership and use do not have to be concurrent.
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