Buying Timberland with a Self-Directed IRA
Buying timberland as an investment takes careful study, patience, professional assistance, and, of course, money. Because most land does not service debt well, the majority of Fountains Land’s transactions are cash deals. Purchase funds come from a variety of sources – personal wealth, the sale of another property, or the wise investments in traditional assets (stocks, bonds, mutual funds). A lesser known, but steadily growing source of funds for timberland and other real estate investing, is the self-directed Individual Retirement Account (IRA).
Self-directed IRAs are similar to standard IRAs with the key difference being that the investor has much greater flexibility to invest in alternative or “non-traded” assets. While this investment vehicle has been available since 1974, only 2% of the nearly $7 trillion in total IRA balances is held in self-directed IRAs. Much of the reason why those with retirement funds haven’t heard of this option is that most IRA custodians/financial advisors focus solely on the standard investments like stocks, bonds and CDs. However, given the volatility of the stock market, although presently at all-time highs (for now), an increasing number of savvy investors are seeking alternatives that can provide greater diversity, and thereby greater stability, to their total retirement portfolio.
For the vast majority of Americans, the IRA is the largest amount of money they may ever hold in their lifetime. While diversifying assets is important to long-term growth, so too is protecting the principal and balancing risks against the reward. Therein lies the second most likely reason why many have avoided tapping their retirement funds to diversify into less well-known alternatives. The benefits of owning timberland via a self-directed IRA are well-documented, but the asset class and the IRS obligations must be fully examined and understood well before deciding to crack open the retirement nest egg for acquisition funds.
Socially conscious investors who seek to diversify from the traditional non-renewable industries are also turning to the self-directed IRAs. A professionally managed timberland investment provides a renewable, sustainable product made from trees. In addition, well-managed forests provide clean air, clean water, wildlife habitat and local jobs for foresters, loggers and mill workers.
Timberland is a unique type of real estate that is well-known for its advantages including inflation protection, wealth preservation, biological growth and reasonable tax status. For instance, due to biological growth, timber volume increases annually regardless of economic conditions. Potential losses due to fire, insects and disease are minimal in the Northeast, although these factors can affect growth to varying degrees in other regions of the US.
Another positive attribute associated with timber is “in-growth” whereby small trees with low market value (pulpwood, biomass chips) eventually grow into large trees (saw logs, veneer logs) with much higher market value. Acquiring timberland with a mix of tree sizes or “age classes” is an important consideration. Purchase price, investment horizon, and future cashflow from timber harvests are equally important factors in the due diligence process.
Fountains Land’s brokerage team is comprised of experienced foresters who can help investors evaluate these physical and biological characteristics in order to determine if a particular timberland tract will meet their long-term objectives. “Long-term” is the operative word here as timberland, especially in the Northeast, requires patient money. Depending on the age of the forest at the time of acquisition, it could easily be 10 to 20 years before a commercial harvest can be conducted. Keep in mind that timberland has low liquidity as an investment. Unlike traditional assets such as stocks and bonds which can be sold in minutes, it takes time to find a buyer for real estate, especially timberland.
Just as important as knowing the investment attributes of timberland are Internal Revenue Service rules that an investor must follow in order to participate in a self-directed IRA. Custodianship of retirement accounts holding non-traditional assets involves a higher degree of documentation and administration. There are limited number of such IRA custodians willing to provide such guidance; however, there are some good choices available to investors.
There are specific rules related to self-directed IRAs, especially with real estate, that must be followed or the investor could be subject to significant taxes and penalties. Here is a brief primer on how real estate, particularly timberland, must be treated under this program.
- The land is titled in the name of the IRA instead of the individual (this is the case for any IRA-owned asset); in other words, the property’s buyer is the IRA, not the investor. This is the reason why paperwork must be managed by a qualified IRA custodian.
- All expenses related to the property – such as the purchase price, taxes, forest management fees, road-building and maintenance, tree-planting, herbicide spraying, etc. - must be paid by the IRA account.
- Any revenue derived from a timber harvest, other cash crops, or subdivisions must be paid back into the IRA before any distributions can be taken by the investor.
- The investor cannot use the property for personal reasons (the investor cannot have a camp or second home on the property). The timberland must be treated as an investment and not for the benefit of a “disqualified person” – e.g. you, your business or family members.
- Management of timberland must be conducted by a third party. If the IRA owners provide any “sweat equity” activities, such as conducting a small-scale firewood thinning, there could be penalties.
To better understand these and other rules associated with a self-directed IRA, download Publication 590 from www.irs.gov. Before your eyes begin to glaze over while reading through this hefty document, consider contacting an investment firm that specializes in this type of financial custodianship. Two prominent companies are Equity Trust, www.trustetc.com, and Pensco, www.pensco.com. They both offer excellent primers on their respective websites.
Another good source of information is the IRA Association of America (IRAAA), www.iraaa.org, an alliance of financial planners, real estate agents, attorneys, bankers, investment advisors, and CPAs. According to their website, “the field of Self-Directed IRA & 401(k) investment is inundated with misinformation and questionable marketing practices. Our members adhere to the highest levels of ethics and conduct.”
In summary, initiated investors who wish to add timberland to their retirement portfolio and who are willing to do the necessary homework can do so successfully via a self-directed IRA. With the guidance of a qualified IRA custodian and Fountains Land brokers, an investor can make informed decisions about putting some of their personal savings to work in timberland…and what better way to grow wealthy over time than to grow trees for the future.
For additional information about timberland investment opportunities, please contact a Fountains Land broker – see our Contacts page for one in your region.
Patrick Hackley - The writer is a professional forester and timberland broker with Fountains Land who has served timberland owners in the Northeast since 1987. Special thanks to Equity Trust for providing information for this article.