Peter moves back to his abandoned old house and lives inside. It is boarded up and unsafe and covered with grafitti, but in Peter's disturbed mind, the house is gorgeous and his wife and kids live there happily.
Peter begins to re-connect with his old neighbors, including Ann Patterson . She recognizes Peter as her neighbor from five years ago and wonders why he is living in an unfit house. She begins to realize that Peter is still insane and that he is imagining that his dead family is alive in the house. He speaks as if everything is normal, and this alarms Ann.
Within Peter's delusion, Trish and Dee Dee start seeing a man watching the house from the front yard, and Will and Libby find evidence that something has happened to the house's previous owners. Will eventually discovers that, years prior, a woman named Elizabeth and her daughters Beatrice and Katherine were murdered, and her husband, Peter Ward, was the main suspect because they believed he was the only one at the house during the shooting, but was let off because of lack of evidence. Will starts believing that Peter Ward has returned and is stalking his family, and starts searching for more information about him. He doesn't yet realize that he himself is Peter Ward and that Will does not exist.
Will's research leads him to the psychiatric hospital where Peter Ward was committed after being arrested for murdering his family. There, Will discovers that he is Peter Ward, and created a new identity for himself in order to cope with the grief of his family's death. When he was still in the mental hospital being treated, he decided that he could not have been Peter Ward because he would never kill his family so, he made up a new name in which he used numbers ( W1-1L 8-10-10). In turn, the audience learns that everything that has occurred up to this point in the movie was just fantasy. Peter is informed by the doctors that he claimed he was innocent. He returns to his house, which is actually abandoned and decrepit, and converses with the projections of his wife and daughters, who claim that they believe in his innocence.
Peter eventually becomes closer to Ann and her daughter Chloe, and discovers that they were friends of his family. Ann believes in his innocence and encourages Peter to live a new life in order to heal himself. Peter eventually decides to return to his old house to confront his memories and, with Ann's help, realizes that he did not kill his family. It was a local man named Boyce , who broke into the house and shot Peter's wife and daughters. During the fight, Elizabeth tried to shoot Boyce and accidentally shot Peter, allowing Boyce to recover the handgun and kill her. Peter was then accused of the murder.
Peter and Ann are suddenly attacked by Boyce and Ann's ex, Jack, who reveals that he had hired Boyce to kill Ann so he could avenge her for divorcing him. Boyce got into the wrong house and accidentally killed Peter's family. Jack decides to kill Ann and set the house on fire, framing Peter for her murder, and shoots Boyce as punishment for his early failure. As they try to ignite a fire, Peter escapes, overpowers Jack and saves Ann. Boyce douses Jack in gasoline in revenge for being shot, but Jack shoots him in the head before being consumed by the flames.
While Ann and Chloe re-unite, Peter confronts the ghosts of his family and they forgive him and tell him to leave to save himself. Peter escapes, having finally discovered the truth about himself and gained inner peace.
A year later, Peter has returned to New York City and published a book called Dream House about his recent experiences. It was a best selling book and he continued on with his life.
