Did you know you can invest in unimproved land with an IRA? This alternative asset presents diverse uses that, in turn, present more than a few income-earning opportunities. We aren’t talking about taking a taxable distribution from your retirement plan to invest, either. If you use a self-directed IRA, you can invest the account into alternatives to the stock market like real estate, private equity, private lending, gold, and more. Your IRA owns the asset—and all income (including capital gains on property sales) is deposited directly into your IRA on a tax-free or tax-deferred basis.
This article explains unimproved land and how to invest with an IRA. We’ll outline the differences between unimproved, improved, and raw land. You’ll learn various uses of unimproved land and some of what developing this type of property entails. We’ll also cover how investing with a self-directed IRA works, prohibited transactions to avoid, and how your IRA can use a non-recourse loan or partner funds to invest.
Read on to discover how unimproved land assets can help you build retirement wealth in your IRA.
What Is Unimproved Land?
Unimproved land is often found in rural areas (think large tracts of land in the country) and on the outskirts of towns and cities (wide open spaces with no houses or buildings). It’s often mistaken for raw land, which is property that is completely untouched in terms of development or maintenance.
Unimproved land is ripe for development and may have had some modifications and maintenance, but it lacks the basic facilities that improved land has, like utilities, water, infrastructure, buildings, etc. As such, unimproved land typically costs less to buy than improved land does. And if you have an eye for how land like this is used, including potential future development, unimproved land is a real estate investment worth considering for your self-directed IRA.
Improved Land vs Unimproved Land
As mentioned above, improved land is property that has some modifications to it, like utilities and other features, such as roads, sewers, and sidewalks. Unimproved land has not been fully modified, and most often lacks access to these amenities. Because it costs less to purchase, investors often scoop up potential promising opportunities for their portfolios. Some investors buy and hold the land without making any improvements with the goal of selling later for a profit when real estate sales are on the rise. Others choose to develop the land, in whole or in part, to reap those returns upon completion of the project.
Raw Land vs Unimproved Land
Raw land is ideal for long-term investment goals with potential high returns, especially if your goal is to simply buy and hold then sell when real estate prices are high. However, raw land typically is more challenging to develop if that’s your plan. This property may have no access to roads, utilities, or running water. So, while it’s less pricey to purchase, raw land has a much higher price tag to develop than it’s improved and unimproved counterparts.
If you’ve read this far, chances are you’ve decided to invest in unimproved land. So now we’ll dive into the various uses and income potential this type of vacant property presents.
Can You Build on Unimproved Land?
Yes, you can. As mentioned earlier in this article, investors often eye unimproved land for building purposes. Depending on the area of the land you’re considering, the addition of residential and/or commercial property may be a good choice.
Residential property includes single and multifamily property such as condos, duplexes, and mobile homes. Commercial property includes office space, restaurants, retail outlets, and more.
The strategy of developing unimproved land can be profitable if the property lies on the outskirts of desirable and expanding urban areas or is otherwise prime land for residential or commercial uses. However, development does cost money. So even if the purchase price is low, development costs impact future profitability. Keep that in mind when investing in unimproved land with an IRA. All profits flow tax-sheltered into the account, but all expenses to develop the property must be paid with IRA funds. Make sure your account has ample funds to facilitate your goals before you invest.
Before you invest, you must understand the laws and regulations that govern the land you’re purchasing. Zoning laws determine whether a parcel is strictly residential or commercial. There may be limits on agricultural land use, as well as environmental laws you must follow. Due diligence in this area whether you build or not is critical to ensure the land you purchase can be used as you intend.
Other Unimproved Land Investment Uses
Savvy investors know their goals before they invest. Unimproved land provides several income-earning opportunities to explore and determine which best fits your goal. Below are a few of the more common uses.
Oil, mineral, and gas profit potential. Whether it’s land that’s currently being mined for these assets or is a potential future drilling site—the investment potential for oil and mineral royalties can be significant. The long-term returns on this land are what investors desire.
Timberland development. Tree farms present another long-term opportunity. Trees are planted and the land cultivated over time to produce softwood and hardwood varieties which are harvested and sold every 15 to 20 years.
Agricultural use. Livestock (meat and dairy) as well as chickens and crops fit into the farmland category, and all are worthy investment choices because…everyone must eat.
Develop land for an IRA-owned business. This is interesting because the benefits are two-fold, especially when investing with your IRA. Not only can your IRA own land, it can also hold a business as an asset.
For example, let’s say you’ve always dreamed of owning a winery. Well, you can create and run that business inside of your IRA. In short, here’s how that would work: Your IRA purchases the unimproved land and further pays the cost to develop that land into a winery. The land is an IRA-owned asset, and so is the winery. All profits the winery makes flow directly into your IRA enjoying the same tax-sheltered status any other asset does, and helps you build wealth for retirement.
IRA-owned businesses can be advantageous and tricky. Businesses in an IRA typically earn what’s called unrelated business taxable income (UBTI). This income is subject to unrelated business income tax (UBIT) that your IRA may owe. It’s important to discuss the pros and cons with your CPA or financial advisor before making the decision to invest this way.
Steps to Invest in Unimproved Land with an IRA
- Open and fund a self-directed IRA. You can do this by transferring funds from an existing IRA or by rolling over funds from an old 401(k) into your new plan. You can also make a cash contribution to your self-directed plan as long as that contribution falls within annual contribution limit rules. Once your account is funded, you’re ready to invest.
- Perform due diligence on the investment and its elements. As account owner, you are responsible for vetting all investments. With unimproved real estate, this includes understanding zoning laws, calculating construction costs if you’re going to build, evaluating challenges and costs of establishing infrastructure, access to utilities, etc.
- Know the rules on investing with a self-directed IRA. All investments are titled in the name of your IRA. Your IRA receives all income the investment earns, and all expenses related to the investment must be paid with IRA funds. As the IRA owner, you’re responsible for reviewing and approving all investment documents during the acquisition process. Additionally, you’ll want to educate yourself on prohibited transactions relevant to IRA-owned assets, some of which are covered below.
Prohibited Transactions to Avoid with Unimproved Land in an IRA
Opening a self-directed plan to invest in unimproved land is easy enough. As the owner of the account, you call the shots. You decide how your retirement funds are invested and have the freedom to choose from a large pool of alternative assets to help build retirement income. But, with that freedom comes a bit of responsibility, which is briefly covered below. There are prohibited transactions and disqualified persons your IRA must avoid dealing with to comply with IRS rules and regulations.
For example, you and other disqualified persons relevant to your IRA cannot:
- Live on or rent IRA-owned property
- Purchase property from or sell property to your IRA
- Perform construction or other work, including maintenance, on IRA-owned property; these activities must be performed by third parties
- Conduct any activity on the property that is considered personal use
Who are disqualified persons?
- The IRA owner (you) and your spouse
- Your parents and grandparents
- Your children and their spouses
- Investment advisors, managers, and fiduciaries or anyone providing services to your IRA
- Any corporation, partnership, trust, or estate in which disqualified persons have a 50 percent or greater interest
Retirement plan funds and income generating investments in the plan are meant to benefit you in retirement, not before. It’s critical your IRA avoid prohibited transactions and dealings with disqualified persons. Failure to comply to these and other rules for IRAs as defined in IRC 4975 can cause penalties, taxation, and even disqualification of your IRA’s tax-sheltered status.
Get Started with Advanta IRA
Advanta IRA is comprised of an elite team of IRA specialists with over $2.5 billion in client assets under management and 20 years in our industry. As a self-directed IRA administrator, we provide a level of service to our clients that’s not often found in our industry. With us you get a dedicated account manager who helps you navigate investment processes, IRS rules, and regulations that govern your account.
We offer free education through weekly webinars and articles on self-directed IRAs and alternative investments. Our Alternative Investing Advantage podcast features guests who cover investing topics, services, and strategies. We also host a bi-monthly virtual investor marketplace—Pitch, Promote, & Prosper, which connects like-minded individuals who can pitch their investment deals and find new opportunities from others.
If you’d like to learn more or open an account, contact Advanta IRA today.
Additional reading on real estate in an IRA:
Case Study: Partnering IRA Funds to Invest
Self-Directed IRAs vs Traditional IRAs: Which Plan Is Best for You?
Top 4 Ways to Invest in Real Estate with an IRA