Several times a year farmers ask me if they can own farmland in an IRA. The technical answer is yes. But the more important and practical answer is you typically should not own farmland in an IRA.
PROHIBITED ACTIONS
Most farmers who want to buy land in an IRA or retirement account want to farm the land. Also, in many situations, they would like to borrow part of the money to purchase the land.
This will lead to a prohibited transaction in the IRA or retirement plan, which means the IRA is fully taxable.
What actions are prohibited? Here is a brief overview:
- The farmer or even a close relative cannot farm the land.
- Farmland rent should be based on fair market value.
- The farmer can’t personally do any work on the land. This means, for example, you can’t mow the waterways, paint a building on the land, etc.
- If you borrow money to purchase the farmland, you cannot personally guarantee the debt.
- If you do borrow money to buy the land, part of your rental income will be subject to income tax. The IRA will need to file an income tax return.
- Once you reach age 72, you might need to partially distribute the land each year. This is needed to meet minimum distribution requirements, which requires additional legal work.
To own farmland inside of an IRA you will need to find an IRA custodian, which will handle the transaction and ongoing ownership of the land. This will result in fees that can easily eat up 10% to 20% of the annual rents.
Plus, each year you will need to obtain a qualified appraisal to set the fair market value of the property.
CAPITAL GAIN RULES
Other key issues with owning farmland in the IRA is the lack of capital gains treatment on the sale or any step-up in basis. Anything owned inside of an IRA is considered ordinary income when it is distributed.
On the flip side, owning the land individually will result in capital gain treatment when sold or the heirs will receive a step-up to fair market value.
Land owned inside a Roth IRA would be better than a regular IRA. But we would still recommend farmers keep it outside of any IRA or retirement plan due to the issues shared with prohibited transactions. As always, discuss your options with your CPA.
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Paul Neiffer is a tax principal with CLA and author of the blog, The Farm CPA. He grew up on a farm in central Washington and still resides in the state.
