Tax code helps spark boom in 2nd homes


April 01, 2006|By KENNETH HARNEY

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

The annual number of second homes purchased in the United States doubled between 2000 and 2004, according to new research. The boom is being driven in part by demographics - mainly a flood tide of equity-laden baby boomers - and in part by a largely unexpected ricochet 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 a vast pool of 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) and $250,000 (for singles) of gain on the sale of a primary home to be spared from taxation, observed Chung, "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 $500,000 or $250,000 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.

For example, a married couple pocketing $500,000 tax-free from the sale of their longtime family home might use part of the proceeds to downsize into a condominium unit in the center city, and then use the remainder to purchase a vacation retreat an hour or two away.

Call it the downsize-and-add-a-second-home strategy - sort of a real estate billiards shot propelled by tax-free money. Whatever you call it, 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, and especially boomers with above-average incomes. Whereas the average household purchasing a primary home in 2004 had an annual income of about $61,000, the average second-home buyer had an income of about $102,000, nearly 70 percent higher.

Part of the motivation of second-home purchasers has been to diversify household financial assets.

Second homes, along with primary homes, saw an average 55 percent gain in price appreciation between 2000 and 2004, according to Chung, whereas the Standard and Poor's 500 index declined by 15 percent.

"As an investment choice, the housing market presented an attractive alternative" to a stock market that sagged sharply from its 2000 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 1 of every 3 purchases made between 2000 and 2004 was for a second-home getaway or investment unit.

In Florida, the proportion was nearly 1 in 5. Arizona (18 percent) and Nevada (17 percent) also saw significant activity, as did other prime recreational getaway states such as Idaho (13 percent), New Mexico (12 percent) and Utah (10 percent).

The District of Columbia - where 1 of 10 home mortgage closings between 2000 and 2004 was for a second home, almost always in the form of rental condos or townhouse units - was a surprise contender on the national list. The number of such units financed in D.C. grew by a stunning 187 percent during the four-year period studied by Chung.

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 says as long as "boomers are still in their peak earning years and they can afford some homes for vacation purposes or investment."

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