- Hi, Clint Coons here with Anderson Business Advisors,
and in this video we are going
to discuss investing in raw land.
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Okay, so you're thinking about investing in raw land.
Most likely, you're doing that because you plan
to develop the property, so the question then becomes
how do you structure that deal to make sure
that you're not going to have adverse tax consequences?
I can't tell you how many people that we've met
over the years that have really hurt themselves
with the way they've gone about their raw land investing.
I mean, they overpaid in taxes because they didn't
understand the basic tenants of how you want to structure it
to make sure that you're gonna be taxed at the least
or the lowest possible rate.
So when you're gonna go out and buy raw land,
what I would suggest you do is create a LLC in the state
where the property's located, or actually it doesn't
necessarily have to be in the state where the property's
located 'cause raw land initially it's not doing anything,
it's not conducting business, so truth be told,
when you're buying raw land, you can set the LLC up
in Wyoming, Nevada, Delaware, it can be anywhere.
It doesn't really matter.
It doesn't need to be located in that particular state.
So I'm gonna hold the raw land in my LLC.
Now, when it comes to acquiring this land,
the question then becomes what is your timeframe?
When do you plan to start doing things
developing the property?
The mistake that I see a lot of people make here is that
they want to kind of get started on it right now
and doing the subdivisions, but then it's still gonna be
maybe a year out before they actually get really serious
about it, so maybe you start moving some dirt,
bringing in some utilities initially, start subdividing
the property out, short plot,
whatever you're gonna do with that.
That is a problem, okay, because that's going to have
adverse tax consequences for you.
I'll give you an example.
So this client came in, he had owned a piece of raw land,
it was about 50 acres in this area, it was an up and coming,
it was a growing area, and he'd owned it for a few years.
Now, he decided that he wanted to create a bunch
of buildable lots there, so then he did exactly
what I described.
He started pushing through some roads,
bringing in utilities, doing dirt work on the property,
and then after he had done that, he decided you know what,
maybe I ought to go get some advice on how to structure this
and he came into my office and he sat down with me
and he goes, how's this gonna be taxed?
I said well, unfortunately for you, it's gonna be taxed
at the highest marginal tax rate
when you sell all this property off.
He goes wait a minute, it should be long-term capital gains
because I've held it for more than a year.
Well, that's true, it could've been taxed at 20%,
but the mere fact that you went out there
and you started doing stuff, moving dirt on the property.
As soon as you touch that property and start moving it
around or subdividing it out, whatever you start doing
in that context, you've know converted it from long-term
capital gains investment property into ordinary income
property at that point in time because it's looked at
as you're holding this property not for investment,
but as inventory for your development.
So what's key here with raw land is that if you can do this,
if you can wait one year, so if you're buying it
with speculation that you intend to do it in the future,
wait one year before you do anything with your property,
just let it sit there in the limited liability company.
Then, when you get ready to start moving the dirt
and move forward with your project,
what you need to do is this.
You need to create a separate C corporation.
This is my C-corp.
This becomes my development corp up here.
This is gonna be my development corporation.
Now, what I'm gonna do is enter into a purchase
and sale agreement with my LLC, so my LLC is going
to sell the property to that C corporation,
and when we put these deals together, a lot of times
what I'll do is we'll sell, let's say the property
you bought it, and we could use some numbers here.
So you bought the property for $700,000, okay,
then a year later you're looking to sell it to the corp.
You figure after you develop it, you get all these
lots available, if you're gonna sell them to builders
or whatnot, you think it's gonna generate
for you 1,800,000 total on the sale of this.
So if this is my basis, what I might do is enter
an agreement with my corporation to sell it
to my corporation for 1,500,000.
So by doing that now, you take the difference between 700
which is your basis and the sale price of 1,500,000,
that's an $800,000 gain that you're gonna generate
from selling this land to your corporation,
but what's key here is that gain
is not gonna be ordinary income to you.
That is if you did it in your LLC,
that would be ordinary income to you.
Now it's gonna be long-term capital gains rate,
so it's gonna be taxed at a flat 20%, so your total tax
liability on this would be 160k.
If you didn't do it this way, then it would be taxed at 37%
so you can see by those numbers here you'd be
at about $300,000, so this one strategy here in my example
could save you potentially $140,000 in taxes.
Now, when I've talked to investors before when we talked
about waiting for a period of time before you do this,
they're often like, well I want to do it right away.
Yeah, that's fine, but are you gonna be able to make up
that $140,000 difference that you're gonna save in taxes
by getting jumping ahead right today on that deal?
You know, so you have to do the math yourself to figure
out the investment if it makes sense to follow this strategy
but this is what occurs.
So we put in this agreement.
When I'm writing this up, sometimes we'll even putting
a participating note, so if you want to even pull a little
more money back out you can write this out with some people
refer to as contingent interest that you're gonna get
at 1,500,000 and the interest rate is gonna be 10%
of the profits on the sale of the property,
so then once this property goes into here,
into the corp, then the corp is going to do all of this
and bring in the dirt work so the corp becomes
the developer, so when the corporation sells those lots off
and they generate 1,500,000, well their cost basis in it
number one was 1,500,000, so now they have $300,000 gain.
Let's say they spent $200,000 on the dirt work
and development there, so now it's $100,000
in taxable income to that C corporation which is gonna
be taxed at a flat 21% at that C corporation level,
so basically you're developing the land and you're keeping
your tax rate down at 20% rather than the 37% you could run
into if you just did it in your LLC
or you did it in your own name, so what's key here,
hold the property for a year before you start moving
anything around, otherwise it's gonna be looked at inventory
and you're gonna blow up your deal and you're gonna
be paying a much higher tax rate when it comes to dealing
or developing raw land.
My name's Clint Coons with Anderson Business Advisors.
If you want to learn more about this strategy,
talk to us, make sure you sign up for a free strategy
session, check the notes out below, I've got a link there
that you can sign up and get that free strategy session
to talk about how to structure your raw land investing.
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