Are Self-Directed Investments in Land Contracts the Same as Buying Real Estate?
Purchasing real estate is a great investment when using a Self-Directed IRA, especially if you’re looking for tax-deferred or tax-free income potential with rental property. If you’re looking for something different, or have creative financing in mind, there’s another way for your IRA to collect an ongoing stream of income– land contracts.
What is a Land Contract?
Land contracts are a type of promissory note and are often referred to as owner financing, seller financing, or contract for deed. A property owner may choose to sell to an individual who, for whatever reason, is unable to obtain financing from a bank or other traditional mortgage lender. Rather than receive the full purchase price of a property up front, the property owner can enter into an agreement, or note, with a buyer to accept regular monthly payments over time until the buyer has paid the outstanding balance in full.
If your self-directed IRA enters into a land contract with a buyer, it sets the terms of the contract, similar to a mortgage lender. You should also adequately vet the buyer before you sign the contract.
Selling a property your IRA owns isn’t the only path to a land contract. Your IRA can also buy an existing land contract. You might buy a land contract from someone who needs to raise cash quickly, in which case you could buy the note at a discount and start collecting the monthly payments.
How Does a Land Contract Work?
Once you’ve found a buyer, it’s time to set the terms of the contract. Your self-directed IRA and the buyer will agree upon a number of elements, including:
- Purchase price – this may be negotiated higher than what would have been the normal list price because you’re providing an opportunity to the buyer, outside of traditional financing
- Down payment – you may choose to require a large cash down payment, often up to 20% of the purchase price
- Interest rate – the fee you’re charging on the loan’s outstanding balance, typically in the range of 5-10%
- Maturity date – when the contract expires and the outstanding loan amount becomes due
- Miscellaneous terms or conditions such as late fees and where payments should be sent
Once both you and the buyer have signed the land contract, the buyer takes possession and is considered to hold equitable title to the property. During the period in which the buyer is making payments, he or she is also responsible for paying taxes and insurance and maintaining the property.
Your Self-Directed IRA maintains legal title to the property. The deed to the property will not transfer to the buyer until the note is paid in full and all conditions of the contract have been met.
There are a few ways that your Self-Directed IRA benefits from a land contract investment. Over time, it will enjoy net proceeds that include a potentially higher purchase price as well as interest earnings. The monthly payments provide a steady income, and these payments are tax-deferred (Traditional IRA) or tax-free (Roth IRA). Furthermore, if the buyer were to default on the note, you can initiate forfeiture, in which the buyer forfeits equitable title and the IRA gets to keep the payments collected as well as the property.
Land Contract versus Real Estate Purchase
Buying real estate in your Self-Directed IRA is pretty straightforward. Your IRA buys a property and holds it to collect rental payments or holds it for sale in order to collect tax-advantaged income (growth). If your IRA holds a land contract, however, it collects regular payments without the hassle of maintaining a property. Both strategies have advantages, but also require due diligence. You need to do your research to make sure you’re lending to a worthy buyer the same way you research a property to make sure it’s a solid investment.