Considerations for Owning Land with a Self Directed IRA
Your wallet, your bank account, and your retirement plan. These are the three piggy banks you want flush with as much cash as possible when trying to paint a pretty financial picture.
Quality investments in land assets can help with the first two, but what about your nest egg?
Can you distance your retirement from the uncertainty of the stock market by leasing farmland, hunting space, or any other such uses for the great outdoors?
You certainly can, and once you understand the remarkable tax benefits available through land investments with your retirement account, you’ll have a new financial tool for your long-term approach.
The virtues of self-directed IRAs, 401(k)s, and other such savings vehicles lie in their tax benefits. All investment methods carry a unique set of perks that, when combined, can boost your overall financial situation.
- Your Money – When you invest your personal funds, you can allocate your earnings toward new business opportunities, your personal income, or anything else your heart desires. However, as with any money you earn, the IRS will come for taxes every April.
- Pre-Tax Plan – Common pre-tax retirement accounts include Traditional IRAs, SEP IRAs, and 401(k)s. These plans enable you to defer your contributions for tax purposes. For example, if you make $50,000 in a given tax year and contribute $5,000 to your Traditional IRA, you’ll only have to pay taxes on $45,000 for that year ($50,000 income - $5,000 contribution = $45,000). Taxes would only come due upon distribution (withdrawal) of cash or assets. These distributions would ideally occur once you’ve reached retirement age, at which point your contributions have hopefully generated positive returns and you’ve fallen into a lower tax bracket. SEP IRAs and 401(k)s provide the same tax benefits but also offer a particular advantage to self-employed individuals, as the annual contribution limits of these accounts are far higher than those of a Traditional IRA.
- Post-Tax Plan – Roth IRAs are the most typical accounts you’ll see in this category, although some 401(k) plans permit Roth contributions as well. These accounts task investors with paying full taxes on their contributions, but they can experience significant savings down the road. Once a Roth IRA holder reaches age 59 ½ and earnings have remained in the account for a minimum of five years, those earnings can be distributed 100% tax-free. If we reference our previous example, a $5,000 contribution to a Roth IRA would mean you pay taxes on your full income of $50,000. If you apply that contribution toward a land investment and it grows to $20,000, a full distribution of the $15,000 profit, if qualified, will bear no additional tax obligations. Because you already paid taxes on your $5,000 contribution, you could distribute those funds anytime without incurring duplicate taxes.
If you spent the last few decades contributing to a pre-tax 401(k) but would like to yield the tax advantages of a Roth IRA, you won’t have to start over. Instead, you may roll your 401(k) into a Traditional IRA (with the same pre-tax structure) and then execute a Roth conversion. Per current law, there are no limitations on the number of Roth conversions you may complete, nor are there limitations on their values. As such, $10 million can be converted in same manner as $10,000. The converted balance will be taxed like a distribution from a Traditional IRA or a contribution to a Roth IRA (a Roth conversion essentially represents a combination of these transactions). Keep this in mind and consider a conversation with your accountant or tax professional before initiating a conversion.
If you can legally invest with the money in your pocket, you can put your tax-advantaged retirement dollars to work in the same ways. Beyond common practices like developing property or holding and flipping, the IRS recognizes other uses of land as valid IRA investments. Buying a series of acres to develop a potentially profitable enterprise is no exception.
Once you have the support of a quality IRA provider, you may find it’s easier than you think to get started:
- Open your Self-Direction IRA – Not all IRA providers are created equal. You need a customer service, education, and technology-based company to address your questions and simplify the process. Online applications allow prospective investors to create their new retirement accounts in a matter of minutes.
- Fund the Account – Once your new account is up and running, you can deposit funds using one (or all) of three methods. Contributions are direct deposits of personal funds (as we discussed in our previous examples). Depending on your age and the account type, you may deposit up to a certain amount per year.
You can also move funds from other retirement plans. If you open a Traditional IRA and have funds in a similar account (another Traditional IRA, a SEP IRA, or a SIMPLE IRA), you can execute a transfer to bring some or all of those funds into your new self-directed IRA. Roth IRA-to-Roth IRA transfers are very common as well. If you have a dissimilar but qualified retirement plan (a pre-tax 401(k), a 403(b), etc.), you can roll those funds into the IRA. Some publications or advisors may use “transfer” and “rollover” interchangeably, but understanding the difference between these transactions can help ensure a smooth and compliant movement of funds. Consult with your IRA provider to help determine which of these options will suit your needs.
- Make the Investment – This is where your business expertise comes into play. You can review raw land opportunities; qualify partners or clients in accordance with your business model; and personally close deals on behalf of your retirement plan. You won’t have to hire an attorney or account representative to negotiate terms, unless of course you want to. If your transactions occur predominantly on the internet, some sites allow you to browse properties and initiate retirement investments without ever having to leave the asset provider’s webpage.
In a nutshell, self-directed investing empowers you to duplicate your established procedure with a few minor exceptions. Documentation associated with the investment must be titled in the name of your retirement plan and never in your personal name. You’re still the engine behind all investment activities, but the “name” described on the asset paperwork must reflect ownership by the account itself. Furthermore, if you want to lease farmland to direct family members (your spouse, your children, your parents, your grandchildren, your grandparents, etc.) you’ll have to save those opportunities for investments with personal funds. The IRS prohibits you from conducting IRA business with yourself (you cannot lease your IRA-owned land and make payments to your own account), your aforementioned linear family members, their spouses, or any designated fiduciaries to your retirement plan. Non-linear family members like cousins or siblings, in addition to any trusted friends or business partners, are all non-disqualified and may therefore lease your IRA-owned land. Finally, if you personally collect lease payments on behalf of your IRA, the funds must return to your plan and may not commingle with your personal funds. To this same effect, any expenses inherent to the investment but be paid by cash from the IRA.
Once you understand these small distinctions, you may find the process of investing in land with a self-directed IRA to be a lucrative and replicable option for building wealth in the long run. By supplementing your regular income with retirement investments that don’t rely on the whims of Wall Street, you can secure your finances today while taking steps toward a better tomorrow.
Written by Clay Malcolm
Clay Malcolm is Chief Business Development Officer at New Direction IRA, a self-directed IRA provider that empowers investors to diversity their retirement portfolios with alternative assets. With over 20 years of management experience and a rich knowledge of self-directed retirement, Mr. Malcolm provides client and broker education in the fields of land investing and IRS rules surrounding Real Estate IRAs. Mr. Malcolm earned his Bachelor of Science in Communications from Northwestern University. You can contact New Direction IRA at 877-742-1270 or [email protected]