I don't know how to deal with the period in this quotation (or similar quotations where a period appears in the middle). Is my version 1 below acceptable or do I need to break it down (as in 2)?
My instinct says 1 is okay, but I'm not sure. I'd be grateful for clarification.
As it's a quotation, why break it up? 1) seems correct to me.
One strategy is to avoid the issue :
Stanley thought that his and Zero’s situation was no mere coincidence: "It had to be destiny.”
That would be my first choice. Or you can dish the quotation out in two servings:
Stanley thought that his and Zero’s situation was "more than a coincidence"; he thinks (or says) that it "had to be destiny”.
Or you can use brackets to indicate a minor change and ellipsis to indicate omission of irrelevant matter, but this can add unnecessary clutter:
Stanley thought that his and Zero’s situation was "more than a coincidence ... [it] had to be destiny.”
I'm pretty sure both 1 and 2 are correct.
2 may possibly err in capitalizing "It," as apparently quotations are supposed to start with a lowercase letter when "used as a syntactical part of a sentence" (Questions on Citation, North Carolina State University Online Writing Lab; this page is itself actually citing The Chicago Manual of Style here). The Manual gives an example with "that":
With another aphorism, he reminded his reader that "experience keeps a dear school, but fools will learn in no other"—an observation as true today as then.
But in another place on the web, I found the following, apparently conflicting advice:
If you are using the word "that" to introduce a quotation, do not also use a comma. These two sentences show the two options.
James Loewen states that "Socialism is repugnant to most Americans" (33).
James Loewen states, "Socialism is repugnant to most Americans" (33).
This example is from "Punctuating Quotations," in the Stylebook for Illinois Valley Community College. Note that here, a capital letter is used after "that." I'm not sure what the reason for the difference is; either these are two different acceptable styles, or one source is wrong, or there is a subtle difference between the grammar of these sentences that I'm missing.
But that's a bit of an aside. Sentence 1 seems to be grammatically correct, and it also sounds better to me; I would go with that. I do see why you had doubts about it, though... it's a little odd that the quotation begins in the middle of one sentence, but then the sentence ends before the quotation does. I'll try to find a source that explicitly mentions this kind of situation; I haven't been able to yet, but my instinct, like yours, tells me that it's OK.
If you decide not to use 1, I wouldn't use 2 but 3:
