Tourney Question

[2in10se]

I played a home game recently and this situation came up.
Player1(Dealer) Player2(SB) Player3(BB)
Player1 raises, Player2 folds, Player3 goes all in and Player1 calls eliminating Player3 the big blind. Now, how do the blinds rotate? Player1 now becomes the big blind and Player2 becomes the dealer with no small blind for this round right? This is how I thought the blinds rotate but the host says that player2 (who just paid the small blind) has to pay the small blind again! He said that when your heads up the dealer is also the small blind which I agree with him on that but that wont be until the blinds rotate again, right? If we do it his way, Player2 will have to pay the small blind twice and thats what I didnt agree with but Im still not sure. We were playing standard poker rules no custom rules or anything. So can someone tell me what the proper blind placement is when your three handed and the big blind gets eliminated, I want to make sure the game is fair. Thanks in advance.