Capital Gains Tax on a Second Home

A second home is a capital asset with no exclusion, so the whole gain is taxed and a loss is not

Section 121(a) excludes gain only on property owned and used as the taxpayer's principal residence for two of the five years before the sale. A vacation house or city apartment you use part of the year does not qualify, however much you love it. Its gain is long-term capital gain after more than a year, taxed under section 1(h) at the 2026 breakpoints in Rev. Proc. 2025-32: 0% to $98,900 joint and $49,450 single, 15% to $613,700 and $545,500, 20% above.

The Form 8960 instructions say gains on investment real estate, including a second home that is not a qualified principal residence, are net investment income, so the 3.8% tax under section 1411 applies once modified AGI passes $250,000 joint or $200,000 single. The asymmetry runs the other way on a loss: Publication 544 says loss on property held for personal use is not deductible.

Your basis is what you paid plus improvements, so receipts for a new roof, kitchen or dock reduce the gain. With no depreciation on a purely personal home, there is no 25% recapture layer.

Worked example: a single owner sells a lake house held twelve years

Hypothetical, round figures. A single filer bought a lake house in 2014 for $300,000, added $50,000 of improvements, and sells in 2026 for $700,000 with $40,000 of selling costs. Gain: $660,000 less $350,000, or $310,000. Other taxable income is $120,000, so the gain stacks from $120,000 to $430,000, inside the 15% band that ends at $545,500 for single filers: $46,500.

Modified AGI without the sale is $135,000, so with it $445,000, and NIIT is 3.8% of the lesser of $310,000 or $245,000, which is $9,310. Federal total $55,810, about 18% of the gain, plus state tax where the house or the owner is taxed. Run your own numbers with your CPA.

Records decide the gain: basis, improvements and selling costs go on Form 8949

The sale is reported on Form 8949 and Schedule D as the sale of a capital asset held for personal use, and the closing agent usually files a Form 1099-S showing gross proceeds. If the 1099-S does not reflect your commissions and transfer taxes, the instructions let you adjust for those selling expenses on Form 8949 so you are not taxed on gross proceeds.

Publication 551 increases basis for improvements with a useful life of more than one year, such as a roof, an addition or a new septic system, while ordinary repairs and upkeep do not count. On a house held for decades, missing receipts are often the largest avoidable cost of the sale, so rebuild the improvement history from permits, contractor invoices and bank records before you list.

If you inherited the second home rather than bought it, the starting basis is its value at death instead; capital gains tax on inherited property explains that rule.

Moving in before selling recovers only part of the exclusion because of the nonqualified use rule

Living in the second home for two years can make it your principal residence, but section 121(b)(5) withholds the exclusion from gain allocated to periods of nonqualified use. Nonqualified use is any period after December 31, 2008 when the house was not the principal residence of you or your spouse, and gain is allocated by the ratio of those periods to total ownership.

Hypothetical: you bought a beach house in 2016, used it as a second home until 2024, then lived in it as your main home until the 2026 sale. Eight of ten years are nonqualified use, so 80% of a $400,000 gain, $320,000, is taxable and only $80,000 is eligible for the exclusion. Time after you move out, within the five-year window, does not count against you, and neither do up to two years of temporary absence for work or health.

Any depreciation claimed after May 6, 1997, for example during a rental period, is taxable under section 121(d)(6) even when the rest of the gain is excluded.

Renting the house first is what makes it exchangeable, and the IRS safe harbor sets the pattern

A 1031 exchange requires property held for investment or business use. Rev. Proc. 2008-16 says the IRS will not challenge a dwelling unit as relinquished property if you owned it for at least 24 months immediately before the exchange and, in each of the two 12-month periods, rented it at a fair rental for 14 days or more and used it personally no more than the greater of 14 days or 10% of the days rented. The same test applies for 24 months after the exchange to a dwelling acquired as replacement.

If you change the house to a rental, Publication 527 sets its depreciation basis at the lesser of your adjusted basis or its fair market value on the conversion date. Rental years also bring the section 280A allocation of expenses between personal and rental days, which capital gains tax on a vacation rental explains, and section 280A(g) leaves income from fewer than 15 rental days a year untaxed and undeductible.

Exchanging into a building or a traditional DST interest swaps a house you use for property that pays, and the deferred gain follows the replacement. The primary residence and second home 1031 answer and the vacation and short-term rental guide cover usage planning in more depth.