Capital Gains Law, Investment Values Drive Second Home Market

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The annual number of second homes purchased in the United States doubled between 2000 and 2004, from 405,000 to 881,000, according to research conducted by the National Association of Realtors (NAR). Part of the boom is driven by baby boomers looking for investment opportunities that offer higher returns than the stock market and part by the unexpected effect of changes in the capital gains laws.


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The capital gains driver was uncovered by NAR economist Keungwon Chung, who reviewed Federal Home Mortgage Disclosure Act data on loans closed during the period from 2000 through 2004, the Washington Post reports. The data supported the idea that boomers were looking for second homes as investments but also showed that homeowners who sold their primary residences did not always purchase larger more expensive homes as they had done when the gains law required them to “roll over” the gain into their new home.

The tax law, amended in 1997, now permits homeowners to exclude $500,000 (for married couples) or $250,000 (for singles) from the capital gain on the sale of their home. Chung’s study shows that many choose to buy a smaller home and make a down payment on a second home that they will use for either vacation or investment purposes.

Second home buyers have an average annual income of $102,000, Chung reported, according to the Post, well above the $61,000 average income for single home buyer. An earlier NAR study of the second home market, published in 2005, found that although 45 percent of second home buyers used savings for the down payment, 29 percent used equity from a previous home.

States like Florida, Arizona and Hawaii, with large numbers of vacation homes saw explosive growth, with 20 percent or more of all financing for the purchase of a second home. Financing for second homes in Nevada increased by 384 percent during the 2000-2004 period.

The Internal Revenue Service (IRS) recently reminded taxpayers (IRS TAX TIP 2006-54) that the capital gains exclusion is allowed for the sale of their main home and that the sale should meet the ownership and use tests. When the sale does not meet these tests a taxpayer may be allowed to exclude a reduced maximum amount of the gain if he sold the home due to health, a change in place of employment, or certain unforeseen circumstances. Unforeseen circumstances would include divorce, natural or man-made disasters resulting in a casualty to the taxpayer’s home, or an involuntary conversion of the taxpayer’s home.

The IRS also reminded home buyers that points on a refinanced mortgage are deducted over the life of the loan (IRS TAX TIP 2006-55), except if some of the money was used to finance improvements. The points associated with that money may be fully deductible in the year the points were paid.

The second home boom is likely to continue, according to Chung, as long as “boomers are still in their peak earning years and they can afford homes for vacation purposes or investment” – at least another decade – and they will “continue to drive housing markets,” the Post reports.

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