Second homes don't qualify for the Section 121 exclusion
The Section 121 exclusion allows married couples to exclude up to $500,000 ($250,000 for singles) of capital gains from selling a primary residence where they lived for at least two of the five years before sale. A second home — a vacation property you use personally but not as your primary residence — does not meet the use test and gets no exclusion.
All gain from the sale of a second home is taxable. If held more than one year, it is taxed at long-term capital gains rates (0%, 15%, or 20%), plus the 3.8% Net Investment Income Tax if your modified AGI exceeds the threshold.
If you rented the property
A vacation home that was also rented for part of the year is treated as a hybrid. If personal use exceeded 14 days or 10% of rental days (whichever is greater), it falls into the mixed-use vacation home rules. Depreciation is only allowed on the rental-use portion, which means less accumulated depreciation — and less recapture. The capital gain on sale is still fully taxable.
If the property was rented under those thresholds and treated as a fully rental property, the regular rental sale rules apply and the full depreciation taken is subject to recapture.
Converting a second home to a primary residence
If you move into the second home and use it as your primary residence for at least two of the five years before sale, you may qualify for a partial Section 121 exclusion. The exclusion is prorated to exclude only the gain attributable to the qualified use period; the gain attributable to non-qualified-use years is still taxable. Depreciation taken after May 6, 1997 is also excluded from the Section 121 exclusion — it remains subject to recapture regardless.
Frequently asked questions
Does the $500,000 home sale exclusion apply to a second home?
No. Section 121 requires the property to be your primary residence for at least two of the five years before sale. A second home or vacation property does not qualify.
What rate is capital gains on a second home?
Long-term capital gains rates (0/15/20%) apply if held more than one year. The 3.8% NIIT may also apply for high earners. Any depreciation claimed is recaptured at up to 25%.
Can I avoid capital gains on a vacation home with a 1031 exchange?
Yes, if the property was held for investment or business purposes. A vacation home used primarily for personal use does not qualify for 1031 treatment.
Sources
- IRS Topic No. 409 — Capital Gains and Losses
- IRS Publication 544 — Sales and Other Dispositions of Assets
- IRS Publication 946 — How to Depreciate Property
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.