Most people know there is a tax break when you sell a house. Fewer know it does not apply to a lake house that is not where you live, and on Candlewood that distinction is worth a great deal of money, because the cottages here have been held for a long time.
What follows is the published IRS position, quoted. It is not tax advice, and the situations below turn on facts a CPA has to look at.
The exclusion is for your main home only
The IRS describes the exclusion as applying to "the sale of your main home." Under it, you may qualify to exclude "up to $250,000 of that gain from your income, or up to $500,000 of that gain if you file a joint return with your spouse."
Two tests gate it. On ownership: "If you or your spouse owned the home for at least 24 months (2 years) out of the last 5 years leading up to the date of the sale, you meet the ownership test." On use: "If you and your spouse owned the home and used it as a residence for at least 24 months (2 years) of the previous 5 years, you meet the use test." The sentence that precedes both on the same IRS page is the one married sellers need: "If you are filing jointly with your spouse, either you or your spouse must meet the ownership test while both you and your spouse must meet the use test individually." So on a joint return one spouse can carry the ownership test, but each spouse has to satisfy the use test on their own. A couple where only one of them actually lived in the house is looking at $250,000, not $500,000.
Publication 523 states that an individual has only one main home at a time, and where more than one property could qualify it applies a facts and circumstances test rather than a bright line. The plainest statement of the consequence is on the IRS Sale of Residence page: if you have more than one home, you can exclude gain only from the sale of your main home, and you must pay tax on the gain from selling any other home.
So a Candlewood second home does not get the exclusion. Not because of anything unusual about the lake, but because the exclusion was never for second homes.
There is also a frequency limit worth knowing: "Generally, you're not eligible for the exclusion if you excluded the gain from the sale of another home during the two-year period prior to the sale of your home."
Why this lands harder here than almost anywhere
The tax is on the gain, and gain is not simply sale price minus what you paid. You start from the amount realized, which is the sale price reduced by selling expenses such as commission and the conveyance tax, and subtract your adjusted basis, which is your original cost increased by capital improvements. Both adjustments work in your favor, and both depend on records. A cottage bought in the sixties or seventies for a five-figure sum, sold today as waterfront, produces a very large gain, and none of it is covered by an exclusion the property never qualified for.
That is a different situation from selling the house you live in, and it is why the number a lake seller nets can be so far from the number they expected. It sits alongside the conveyance tax, which is the one selling cost Connecticut sets as a percentage of your price.
The inherited version of the same house is taxed very differently
This is the part families are most often surprised by, and it runs the other way.
Where a property is inherited, the IRS position is that the basis "is generally the fair market value (FMV) of the property on the date of the decedent's death," whether or not an estate tax return is filed. An alternate valuation date can be used, but only where the executor files Form 706 and elects it on that return.
Put plainly: the decades of appreciation that would have been taxable gain to the original owner are not carried forward in the same way to an heir whose basis is reset to value at death. Two people can sell the identical cottage and face very different tax outcomes depending on how they came to own it.
I am not suggesting anyone plan around that, and it would be inappropriate to. The point is narrower and practical: if you are selling a family lake property, the tax picture depends on whether you inherited it or bought it, and assuming your neighbor's outcome applies to you is how people get surprised at filing time. The probate mechanics of an estate sale are in selling an inherited lake house is not an ordinary sale.
One exception the IRS names: the date-of-death basis rule does not apply to appreciated property received from a decedent if you or your spouse gave that property to the decedent within one year before their death.
What actually reduces the gain
Basis is not only the purchase price. Capital improvements add to it, which is why records matter more on a long-held lake property than almost anywhere.
On this lake that often means substantial work: a seawall, a rebuilt dock, a septic system replaced, a well drilled, a cottage winterized for year-round use. Whether a particular expenditure adds to basis is a question for your accountant, but the receipts are worth nothing if nobody kept them, and families who have held a property for two generations frequently have not.
If you own a lake house you may eventually sell, the cheapest tax work available is keeping a file of improvement records now.
What to do before you list
- Ask a CPA to estimate the gain before you set a price, not after you have an accepted offer. It changes what net proceeds actually look like.
- Gather improvement records. Anything capital, going back as far as you can. This is the one input you control.
- Establish how you acquired the property. Purchased, inherited, or gifted are three different starting points for basis.
- Do not assume the $250,000 or $500,000 figure applies. On a second home it does not, and building your plans around it is the specific mistake this article exists to prevent.
Common questions about capital gains on a Connecticut lake house
Does the home sale exclusion apply to a second home or vacation house?
No. The IRS applies the exclusion to the sale of your main home, and Publication 523 states that an individual has only one main home at a time. The IRS Sale of Residence guidance puts the consequence plainly: if you have more than one home you can exclude gain only from the sale of your main home, and you must pay tax on the gain from selling any other home.
How much gain can be excluded on a main home?
The IRS states you may qualify to exclude up to $250,000 of gain, or up to $500,000 if you file a joint return with your spouse, provided you meet the ownership and use tests.
What are the ownership and use tests?
Per the IRS, you meet the ownership test if you or your spouse owned the home for at least 24 months out of the 5 years leading up to the sale, and the use test if you owned it and used it as a residence for at least 24 months of the previous 5 years. On a joint return the two tests work differently from each other: either spouse can satisfy ownership, but each spouse must meet the use test individually for the couple to get the full $500,000.
What is the basis of an inherited lake house?
The IRS position is that the basis of property inherited from a decedent is generally the fair market value on the date of death, whether or not an estate tax return is filed. An alternate valuation date may be used only where the executor files Form 706 and elects it. A named exception applies to appreciated property given to the decedent by you or your spouse within one year before death.
Do improvements reduce the taxable gain?
Capital improvements increase basis, which reduces gain, but whether a specific cost qualifies is a question for your accountant. On a long-held lake property this can be significant, seawalls, docks, septic replacement, winterizing, and it depends entirely on whether the records still exist.
Sources: Internal Revenue Service, Topic no. 701, Sale of your home; Publication 523, Selling Your Home; the IRS Sale of Residence real estate tax tips page; Publication 551 for the date of death basis rule; and the IRS Gifts and Inheritances FAQ, which is where the "whether or not the executor of the estate files an estate tax return" wording comes from. Quotations are from those published pages.
Related reading:only one of your selling costs is set by law, selling an inherited lake house, and a summer cottage may not finance as a second home.
More on this area:Candlewood Lake waterfront overview.
If you are weighing a sale and want the net figured properly before a price is set, reach me through ConnorCTHomes.com.
Connor Kostyra, Licensed Real Estate Salesperson, CT Lic. RES.0836348.
Connor CT Homes is a marketing brand. Real estate services are provided through RE/MAX Rise, 1297 Main Street, Watertown, CT 06795.
This article is general information and not tax advice. I am not an accountant, a tax preparer or an attorney. Tax rules change, the quotations above are from IRS pages as published for the 2025 return year, and every situation depends on facts specific to the taxpayer. Consult a CPA or tax attorney about your own sale before relying on anything here.
