The Nation's Housing

Tax Law Gave Rise To Second-Home Boom

By Kenneth R. Harney
Saturday, April 1, 2006

If you are thinking about buying a second home this spring -- or you bought one in the past couple of years -- you are part of a major transformation in the real estate market.

The number of second homes purchased annually in the United States doubled from 2000 to 2004, according to new research. The boom is being driven in part by demographics -- mainly a flood of equity-laden baby boomers -- and in part by a largely unexpected effect of tax-law changes in the late 1990s.

The latter factor was explained by Keunwon Chung, a statistical economist at the National Association of Realtors, who recently studied federal data on hundreds of thousands of second-home mortgage closings. When Congress amended the federal tax code in 1997 to permit up to $500,000 (for married couples) or $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," Chung said.

Under the old 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 residence," Chung said, while using a portion of the tax-sheltered gain to buy a second home, for use either as a recreational property or as an investment.

For example, a married couple pocketing $500,000 tax-free from the sale of their family home might use part of the proceeds to buy a downtown condominium, and then use the rest to purchase a vacation retreat an hour or two away.

Chung's study suggests that the trend is hot, and likely to stay that way for years.

According to Chung, second homes represented just 8.6 percent of all residential mortgages -- 405,000 individual purchases nationwide -- that were closed in the year 2000. By 2004, the number of second-home purchasers had more than doubled to 881,000 and the market share had surged to 14.2 percent.

Who's selling and buying? Primarily baby boomers, according to Chung, especially those with above-average incomes. Whereas the average household purchasing a primary home in 2004 had an annual income of around $61,000, the average second-home buyer had an income of about $102,000.

Part of the motivation for second-home purchasers has been to diversify financial assets. Second homes, along with primary homes, rose in price an average 55 percent from 2000 to 2004, while the Standard and Poor's 500-stock index fell 15 percent, Chung said.

"As an investment choice, the housing market presented an attractive alternative" to a stock market that had fallen significantly from its dot-com highs and has only recently begun to recover, Chung said.

Where are boomers and others investing their second-home dollars? Chung's study found that a dozen states have attracted exceptionally high rates of purchases and cumulative growth during the past four years, whether for recreational use or investment.

In Hawaii, nearly one of every three purchases made from 2000 to 2004 was for a second-home getaway or investment unit. In Florida, the proportion was nearly one in five. Arizona (18 percent) and Nevada (17 percent) also had significant activity, as did other prime recreational getaway states such as Idaho (13 percent), New Mexico (12 percent) and Utah (10 percent). The District -- where one of 10 home mortgage closings from 2000 to 2004 was for a second home, almost certainly in the form of rental condo or townhouse -- was a surprise contender on the national list. The number of such units financed in the District rose 187 percent during the four years Chung studied.

California and Washington, both with 9 percent shares of total loan closings, Maryland (8 percent) and Virginia (8 percent) were all high-growth states for second homes or investor units.

How long can the second-home boom continue? Chung said that as long as "boomers are still in their peak earning years and they can afford some homes for vacation purposes or investment" -- at least another decade -- they will "continue to drive housing markets," especially for second homes.

Kenneth R. Harney's e-mail address

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