Tax Partner
If you’re thinking about selling your second home or vacation property, you may have heard that moving in for two years can help you avoid paying taxes on the gain under the Section 121 exclusion. While that strategy used to be effective, a lesser-known rule added in 2009 could significantly reduce the tax benefit you’re expecting – unless you plan ahead.
Here’s what you need to know before putting up the “For Sale” sign.
The Traditional Benefit: The Section 121 Exclusion
Under IRC §121, a taxpayer can exclude up to $250,000 of capital gain from the sale of a home ($500,000 if married filing jointly) if they meet two simple conditions:
- They’ve owned the home for at least two years, and
- They’ve used it as their primary residence for at least two out of the five years leading up to the sale.
This benefit is generous and often eliminates tax on the sale of a primary home. But it doesn’t automatically apply to second homes or vacation properties – even if you move into them before selling.
The Trap: The Non-Qualified Use Rule
Starting in 2009, a change to the law introduced the concept of “non-qualified use.” Under this rule, if you used the home as a vacation home, rental property, or second home after 2008 and before making it your principal residence, a portion of the gain will be excluded from the §121 benefit – and will be taxable.
What counts as non-qualified use?
Any period after 2008 when the home was not your primary residence.
This includes:
- Rental use
- Vacation use
- Leaving it vacant while living elsewhere
There are a few exceptions (such as temporary absences or post-residence ownership), but generally, non-qualified use chips away at your ability to claim the full exclusion.
How the Limitation Works
If you’ve had a mix of personal and non-personal use, the IRS requires you to allocate gain between the two periods.
Here’s how it’s calculated:
Taxable Gain = Total Gain × (Non-Qualified Use ÷ Total Ownership Period)
Example:
- Bought vacation home in 2012
- Used as a vacation home through 2022 (10 years of non-qualified use)
- Moved in and made it your primary home for 2023–2025
- Sold in 2025 (total ownership = 13 years)
Even though you lived in the home for two years before selling, 10 out of 13 years were non-qualified use.
That means roughly 77% of the gain is taxable, and only about 23% qualifies for the §121 exclusion.
Can You Still Save on Taxes? Yes – With Planning
Even with these limitations, there are still smart ways to reduce tax exposure:
- Move in sooner: The more time you spend living in the home as your principal residence, the larger the share of the gain you may be able to exclude.
- Hold before selling: A longer ownership period post-conversion helps reduce the ratio of non-qualified use.
- Track basis and improvements: Even if some gain is taxable, your capital gain may be reduced by adjusted basis and qualifying improvements.
Key Takeaway
Don’t assume that simply living in your vacation home for two years will let you avoid taxes on the sale. The non-qualified use rule limits how much gain you can exclude if the home wasn’t your main residence all along.
If you’re considering a sale, talk to a WFY tax advisor early – there may still be ways to minimize the tax hit, but timing is everything. Click here to contact a WFY advisor. You can sign-up for our newsletter here to receive more updates.
Wright Ford Young & Co. is headquartered in Irvine, CA and is one of the largest local CPA firms in Orange County. WFY is a full service corporate accounting firm offering audit, tax, estate and trust, and business consulting services to closely held company and family business owners. More information about our Firm can be found at www.cpa-wfy.com.