Capital Gains Tax When Selling Your Key West Vacation Home

Do you owe capital gains tax when selling a Key West vacation home?

Yes. If you're selling a Key West home you've used as a vacation property or second home — not your primary residence — you owe federal capital gains tax on your full profit. The $250,000 exclusion ($500,000 for married couples) only applies to primary residences. Florida has no state income or capital gains tax, so your entire tax burden is federal. Long-term gains (property held over one year) are taxed at 0%, 15%, or 20% depending on your income.

By Jimmy Lane | July 17, 2026

Here's the question I hear more than almost any other right now, especially from sellers who bought in Key West between 2019 and 2022: How much do I owe in taxes when I sell?

It's a loaded question — and the answer catches a lot of people off guard.

If you bought your Key West property as a vacation home, a second home, or a rental investment, you don't get the tax break that primary residence sellers get. The IRS exclusion that lets homeowners shield up to $250,000 (or $500,000 for couples) of profit from capital gains? It doesn't apply to your situation.

That doesn't mean you're stuck. But it does mean you need to know the rules before you decide to sell.

The Primary Residence Exclusion — and Why It Doesn't Apply Here

The IRS allows you to exclude up to $250,000 of capital gains from taxes if you're single, or $500,000 if you're married filing jointly, when you sell a home — but only if you've owned it and lived in it as your primary residence for at least two of the five years before the sale.

For most Key West sellers, that test fails. You live in Chicago, or Denver, or New York. Key West is where you come for holidays and long weekends. Maybe you've even rented it out between your visits. Under IRS rules, that makes it a capital asset — not a primary residence — and the exclusion doesn't apply.

The entire gain from the sale is subject to federal capital gains tax.

How Federal Capital Gains Tax Works on Vacation Property

The good news: Florida has no state income tax and no state capital gains tax. You won't owe a penny to Tallahassee.

The less-good news: the federal government taxes your gain based on how long you've owned the property and what your overall income is.

Short-term gains (property held one year or less) are taxed at your ordinary income rate — potentially 22%, 24%, 32%, or higher. If you flipped a property quickly in the Keys, this applies to you.

Long-term gains (property held more than one year) are taxed at the preferential capital gains rate:

• 0% if your taxable income is below roughly $94,050 (married filing jointly) or $47,025 (single) in 2026
• 15% for most middle-to-upper-middle-income sellers — the most common rate
• 20% for high-income earners above approximately $583,750 (married) or $518,900 (single)

For a typical Key West vacation home seller — someone who bought in 2019 for $800,000 and is selling today for $1.3M — the taxable gain before adjustments is $500,000. At a 15% rate, that's $75,000 to the IRS.

That's a real number. It's worth planning around.

What Counts as Your "Gain"

Your gain isn't just the difference between what you paid and what you sold for. The IRS calculates it based on your adjusted cost basis, which works in your favor.

Start with your original purchase price. Then add:

• Capital improvements you made to the property (new roof, kitchen remodel, pool addition, hurricane impact windows, elevated construction work, new HVAC system)
• Closing costs you paid when you bought (title fees, attorney fees, doc stamps on the mortgage, recording fees)
• Certain selling expenses — real estate commissions, documentary stamp tax paid as seller at closing, attorney fees at closing — can also reduce your gain

What doesn't count: maintenance, repairs, and routine upkeep. Replacing a leaky faucet doesn't increase your basis. Replacing the entire plumbing system probably does.

This is why keeping receipts and records of every capital improvement you've made to your Key West home matters enormously. Sellers who've done substantial work over the years — elevated a structure, added impact windows, rebuilt a dock, renovated the kitchen — can significantly reduce their taxable gain. Every dollar of documented improvement reduces your gain dollar-for-dollar.

The Depreciation Recapture Wrinkle

If you've rented out your Key West property — even part-time — you've likely been taking depreciation deductions on your tax return. When you sell, the IRS "recaptures" those deductions and taxes them at a flat 25% rate, regardless of your income bracket.

This catches people off guard. You benefited from the deduction each year you rented the property. When you sell, that benefit gets partially clawed back.

The depreciation recapture is calculated on the total depreciation you took — or were entitled to take — over your ownership period, not just the years you actually claimed it. A tax professional can calculate your exact exposure here. Know going in that it's a real cost of having used the rental income strategy.

One Strategy Worth Knowing: Convert to Primary Residence

If you're not in a rush to sell, there's a legitimate strategy to reduce or eliminate your capital gains exposure: move to Key West and make it your primary residence for at least two years before selling.

This isn't a shortcut — you have to actually live there. But if the numbers are significant and you've been thinking about making the move anyway, it's worth doing the math. Two years of primary residency qualifies you for the Section 121 exclusion, potentially sheltering $250,000 to $500,000 of gain from federal tax entirely.

I've had clients who've done exactly this. It's not the right move for everyone, but for sellers with a large embedded gain and flexibility in where they live, the tax savings can be substantial.

The 1031 Exchange Option for Investment Properties

If your Key West home qualifies as an investment property — meaning you've been using it primarily as a rental with limited personal use — you may be eligible for a 1031 exchange. This allows you to defer capital gains taxes by rolling your proceeds into another qualifying investment property within a defined timeline.

The rules are specific and the window is tight: 45 days to identify a replacement property, 180 days to close. For sellers with large gains who want to stay in real estate, a 1031 exchange can be a powerful tax deferral tool. You'll need a qualified intermediary and a good tax advisor to execute it correctly.

For properties that straddle the line — part personal vacation home, part rental — the rules get more complex. A tax professional who knows real estate can help you determine how much of your gain, if any, qualifies for 1031 treatment.

What to Do Before You List

The time to think about capital gains is before you sign the listing agreement, not after you're under contract. A few things worth doing now:

• Talk to a CPA or tax attorney who handles real estate transactions — not your general accountant, but someone who specifically understands capital gains, depreciation recapture, and 1031 exchanges.
• Gather your records: original purchase contract, closing disclosure, receipts for capital improvements, records of any depreciation claimed.
• Run a net proceeds estimate that accounts for both your closing costs and your estimated tax liability. Your actual number after everything depends on both.

I walk every seller I work with through a complete net proceeds analysis before we even talk about list price. The tax picture is part of that conversation — because your real number after everything depends on it. The cost to sell a house in Key West covers what you'll pay at the closing table, and how much you net from your Key West home sale walks through the full proceeds picture — but neither is complete without factoring in your tax bill.

Frequently Asked Questions

Do I have to pay capital gains tax if I sell my Key West vacation home?

Yes, if you made a profit. Vacation homes and second homes don't qualify for the primary residence exclusion under IRS Section 121. The full gain — your sale price minus your adjusted cost basis — is subject to federal capital gains tax. Florida has no state capital gains tax, so your liability is entirely federal.

What is the capital gains tax rate on a vacation home sale in 2026?

If you've owned the property for more than one year, you'll pay the long-term capital gains rate: 0%, 15%, or 20% depending on your income. Most Key West vacation home sellers fall in the 15% bracket. Short-term gains (held one year or less) are taxed at your ordinary income rate, which is higher.

Can I reduce my capital gains tax on a Key West home sale?

Yes. You can increase your adjusted cost basis by adding documented capital improvements — renovations, roof replacement, impact windows, elevated construction, pool additions. You can also deduct certain selling expenses. Depreciation recapture and 1031 exchanges are additional factors for properties used as rentals. A tax professional can calculate your specific exposure and the best reduction strategy.

What is depreciation recapture and does it apply to my Key West property?

If you've rented your Key West property and claimed depreciation deductions, the IRS recaptures those deductions when you sell, taxing them at 25%. This applies whether or not you actually took the deduction — the IRS calculates it on what you were entitled to claim. It's a separate calculation from your capital gains rate and is often overlooked until tax time.

Can I avoid capital gains by doing a 1031 exchange on my Key West home?

Only if the property qualifies as an investment property, not a personal vacation home. The IRS requires that the property was held primarily for investment or business use. If you've been renting it out significantly, you may qualify. You'd need a qualified intermediary, a replacement property identified within 45 days, and closing on the replacement within 180 days. A tax attorney or CPA should guide this process.

Selling a Key West home is different from selling almost anywhere else in the country — the market is unique, the costs are specific to Monroe County, and the tax picture for vacation home owners is one that surprises people who don't know to ask.

If you're thinking about selling and want to understand your actual net — after closing costs, after documentary stamp tax, and after capital gains — I'm happy to walk through the numbers with you. That conversation is free, and it's the most useful one you can have before you decide to list. Reach out anytime.

About Jimmy Lane
Jimmy Lane is a licensed Florida Real Estate broker serving Key West and the Florida Keys. Jimmy has been a full time broker for over 25 years and sold thousands of Florida Keys properties.