Key takeaways:
- No primary residence exclusion available: When selling a second home, you can’t use the primary residence exclusion that allows $250,000/$500,000 in tax-free gains.
- Multiple tax reduction strategies exist: Various approaches can help reduce your capital gains tax burden on second home sales.
- Key strategies include: Increasing your cost basis with improvements, potentially using 1031 exchanges, or offsetting gains with investment losses.
Understanding second home capital gains
Whether it’s a mountain house in Aspen, CO or a beach condo in Atlantic City, NJ, your vacation home (and any second home) is considered a capital asset under IRS rules. Unlike primary residences, second homes that are not used as primary residences, including vacation homes and investment properties, are considered to be capital assets under IRS rules and do not qualify for the capital gains tax exclusion.
The amount of capital gains tax you’ll owe on the sale of a second home depends on several factors, including how long you owned the property and your income level. For 2025, the long-term capital gains rates are:
- 0% for single filers with taxable income up to $48,350 and married couples filing jointly up to $96,700
- 15% for most middle-income taxpayers
- 20% for single filers with income over $533,401 and married couples over $600,051
High-income earners may also face the 3.8% net investment income tax, making the effective rate as high as 23.8%.
Adjust your cost basis with acquisition costs and improvements
One of the most effective ways to reduce capital gains is to increase your cost basis — the amount you originally paid for the property plus qualifying improvements.
What you can add to cost basis:
Acquisition costs:
- Purchase price
- Closing costs
- Title insurance
- Attorney fees
- Recording fees
- Survey costs
Capital improvements: Capital improvements are permanent repairs or upgrades, not including routine repairs or maintenance. Examples include:
- Room additions
- Deck or patio installations
- New roofing
- HVAC system upgrades
- Kitchen or bathroom renovations
- Landscaping (permanent features)
- Security systems
Selling expenses: You can also increase your cost basis by adding any qualifying real estate fees, such as real estate commission and closing costs, paid when selling your second home.
Example: If you purchased your second home for $400,000 and sold it for $500,000, it would initially appear that you profited $100,000. But if you also spent $15,000 on acquisition costs, $20,000 to renovate the bathrooms, $25,000 to put on a new roof, and $30,000 in real estate commission, your cost basis may be $490,000, reducing your taxable gain to just $10,000.
For a complete list of qualifying improvements, see IRS Publication 530.
Claim depreciation costs for rentals
If you’ve rented out your second home, you can claim depreciation deductions that reduce your taxable rental income. However, when you sell, you’ll face depreciation recapture.
If you previously rented out the second home, you may also face depreciation recapture, which means any depreciation claimed during rental years will be taxed at a 25% rate when you sell.
While depreciation recapture adds to your tax burden, the annual depreciation deductions during ownership can provide significant tax benefits that may outweigh the recapture cost, especially if you’re in a higher tax bracket during rental years than when you sell.
Convert your vacation home to a rental property
Renting out the property would allow you to treat it as an investment and claim depreciation and other deductions. Converting your second home to a rental property offers several advantages:
- Annual depreciation deductions (typically 3.636% of the property’s value per year for residential rental property)
- Deductible expenses, including maintenance, property management, insurance, and property taxes
- Potential for rental income to offset ownership costs
This strategy works best if you have time before needing to sell and can generate meaningful rental income.
1031 Exchange
A 1031 like-kind exchange allows you to defer capital gains taxes by reinvesting proceeds into similar investment property as established under Internal Revenue Code Section 1031 and detailed in IRS Publication 544. However, vacation or second homes held primarily for personal use do not qualify for tax-deferred exchange treatment under IRC §1031, as clarified in Treasury Regulation 1.1031(a)-1(b) and IRS Revenue Ruling 2008-16.
Safe harbor requirements
Revenue Procedure 2008-16 provides safe harbors under which the IRS will not challenge whether a dwelling unit qualifies as property held for use in a trade or business:
For property you’re selling (relinquished property):
- Own the property for 24 months before the exchange
- Rent the unit at fair market rental for fourteen or more days in each of the two 12-month periods
- Restrict personal use to the greater of fourteen days or ten percent of the number of days that it was rented at fair market rental
For property you’re acquiring (replacement property):
- Same requirements must be met for 24 months after the exchange
For more information, see the IRS guidance on like-kind exchanges.
Important: 1031 Exchanges of vacation properties or second homes that do not follow the safe harbor guidelines may still qualify for tax-deferred exchange treatment, but you should consult with legal and tax advisors.
Offset gains with investment losses
Tax-loss harvesting involves selling securities at a loss to offset gains in other investments. According to the IRS Publication 550, if your capital losses exceed your capital gains, you can reduce your taxable income by up to $3,000 for the year and carry forward excess losses to future years under Internal Revenue Code Section 1211.
How it works:
- Offset like-kind gains first: Short- and long-term losses must be used first to offset gains of the same type, as outlined in IRS Publication 544
- Apply excess losses: If your losses of one type exceed your gains of the same type, then you can apply the excess to the other type
- Reduce ordinary income: You can use up to $3,000 in net losses to offset your ordinary income per IRC Section 1211(b)
- Carry forward: You can also carry forward any excess losses to offset capital gains and income tax in future years, as specified in IRS Publication 550, Chapter 4
Watch out for wash sale rules: If you buy the same investment or any investment the IRS considers “substantially identical” within 30 days before or after you sold at a loss, you won’t be able to claim the loss. This is governed by Internal Revenue Code Section 1091 and detailed in IRS Publication 550, Chapter 4.
Consider your holding period
If you’ve owned your second home for more than a year, you’ll typically pay a long-term capital gains tax between 0% and 20%, depending on your earnings. Short-term capital gains are treated as regular income and taxed according to ordinary income tax brackets: 10