How to Buy Farmland with a Self-Directed IRA

Learn why this little-known strategy is growing in popularity for alternative investments.

According to a famous quote often attributed to legendary philanthropist and businessman Andrew Carnegie, 90 percent of U.S. millionaires earned their fortunes in real estate. While it's unclear whether Carnegie actually uttered those words, many investors cite land ownership as one of their strategies for success. In fact, Bill Gates himself owns more U.S. farmland than any other person or business—a testament to the exceptional value of this method of portfolio diversification. 

Despite the lower risk and higher potential return of farmland and other forms of real estate, few investors have time to run a working farm or fix and flip distressed properties. But if you've always been curious about purchasing real estate as an investment but prefer a more passive approach, consider buying farmland through a self-directed retirement account like a self-directed IRA (individual retirement account). These vehicles allow investors to access impressive growth and diversification through alternative investments such as land and precious metals. 

The basics of self-directed IRAs

At its core, an IRA provides a tax-advantaged approach to investing. While traditional IRAs often have limited investment choices that emphasize stocks, bonds, and mutual funds, self-directed IRAs open the door to alternatives, including farmland. 

You can contribute $6,000 to your IRA for 2021, or $7,000 if you are older than 50. This limit applies whether you open a self-directed IRA with available cash or roll over funds from another retirement account. You can deduct any new contributions (not rollovers) from your taxable income for the year, reducing your tax burden immediately. 

The funds in your IRA grow on a tax-deferred basis, which means you do not pay taxes until you withdraw the funds, which is then treated as ordinary income. Plus if you invest in farmland or another alternative asset and decide to sell it later, you do not have to pay any capital gains tax if you purchased the land through your IRA.

A self-directed IRA can also be a smart strategic option if you have an existing 401(k) from a previous job, as you can roll those funds into a self-directed rollover IRA. Self-employed individuals can also set-up a one-participant 401 (k) plan (also known as a Solo 401(k) plan) with even higher contribution limits ($58,000 per year pre-tax and $64,500 if you are over 50 years old) that has similar self-directing capabilities. 

It’s important to note that self-directed IRAs must meet certain IRS regulations, such as allowing passive but not active farmland investing. These rules let you purchase and profit from land appreciation and any crops sold, but prohibit farm management, repairs, rehabilitation, farm operations, and all other types of active work on the land itself. 

The process of investing with a self-directed IRA

You can choose between two management and payment approaches when self-directing your IRA or Solo 401(k). Using the "checkbook control" approach, you have full control over the investment funds. If you want to purchase shares of farmland or take part in another real estate opportunity, you simply make a wire transfer or write a check for the necessary funds. 

The second option, a custodial self-directed IRA (SDIRA) account, requires approval from a custodian to ensure that you don't break any of the IRS rules associated with these accounts, like the example given above regarding active land management. Another example is if you buy residential real estate, you cannot live in the home itself. However, unlike with traditional IRAs, the custodian does not make investment decisions on your behalf. 

Opening a self-directed IRA typically requires a minimum investment of $10,000 to $50,000. Most accounts also charge custodian fees that range from several hundred to several thousand dollars. Carefully review these fees to find the most financially advantageous IRA for your needs. Often the larger the role the custodian plays, the higher the fees. 

The largest hurdle for investors is often finding a reasonably priced, competent SD-IRA custodian. However, these custodians are becoming more common due to increasing interest in alternative investments that often can provide a powerful hedge against global economic cycles.

Benefits of buying farmland with an IRA

Farmland is often called a recession-proof investment because of its ability to withstand an economic downturn. Historically, when traditional investments such as the stock market increase in value, land values increase as well, and then outperform when stocks decline since food demand remains regardless of a recession. 

Looking closer at the future demand for food, Forbes reports that global food production must increase by at least 70 percent by 2050 to meet the nutritional demands of a rapidly expanding world population, which underscores the ongoing need for higher food production around the globe. Farm investors have the opportunity to benefit from this unmet but much-needed increase in supply. 

And although USDA data shows that domestic farmland consistently outperforms stocks and bonds with double-digit returns, limited availability and environmental challenges such as extreme weather have placed U.S. acreage out of reach for many investors. To combat  these challenges, many investors have pivoted to emerging markets, which offer rich opportunities in citrus, soybeans, and other profitable crops. 

A report from Charles Schwab indicates that 27 identified emerging markets represent 40 percent of the total global economic output, underscoring the potential profit to be found in foreign countries. When exploring the advantages of investing in emerging markets, the Million Acres finance blog cites the low cost of foreign land compared to domestic land, as well as the ubiquity of crops from Latin America, two factors that can help increase overall investor returns.

If you are interested in learning how to buy farmland with your self-directed retirement account, click here to schedule a consultation with someone from Farmfolio. Not only can they answer your questions about passive farmland investing with your self-directed IRA and discuss our currently available opportunities, but they can also recommend providers if you are looking to open your own account.