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Tax Laws Affecting Second-Home Market

According to Keunwon Chung, a statistical economist at the National Assn. of Realtors who recently studied a vast pool of federal data on hundreds of thousands of second-home mortgage closings, the boom in second home purchases in the U.S. is being driven by a largely unexpected ricochet effect of tax law changes in the late 1990s.

When Congress amended the federal tax code in 1997 to permit up to $500,000 (for married couples) and $250,000 (for singles) of gain on the sale of a primary home to be spared from taxation, homeowners did not have to buy expensive replacement homes anymore.

Under prior law, the only way to avoid capital gains taxes was to �roll over� sales gains to progressively larger and costlier homes. The amended tax code, by contrast, allows primary home sellers to buy a smaller, less expensive primary (replacement) residence, while using a portion of the tax-sheltered gain to buy or make a down payment on a second home for use either as a recreational property or as an investment vehicle.

The growth in the second-home market is being driven in part by demographics, but mainly by equity-laden baby boomers who are looking to diversify financial assets. (Second homes saw an average 55% gain in price appreciation between 2000 and 2004 according to Chung, whereas the stock market sagged dramatically from its 2000 dot-com highs� Standard and Poor�s 500 index declined 15%.)

Chung sees the second-home boom continuing for another decade, as long as the boomers are still in their peak earning years and can afford some homes for vacation purposes or investment.