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%.)