Special Purpose Entities (SPEs) in Relation to HUD 223(f) Loans
If you’re a HUD 223(f) loan borrower, in most cases, you will have to structure the legal entity that borrows the funds as a Special Purpose Entity, or SPE. The SPE will then own the project itself.
SPEs for HUD 223(f) Loan Borrowers
If you’re a HUD 223(f) loan borrower, you typically need to structure the legal entity that borrows the funds as a Special Purpose Entity, or SPE. The SPE will then own the project itself. SPEs are typically required due to the fact that they are bankruptcy remote; if the corporation or individual who is the actual borrower declares bankruptcy, the SPE is much less likely to be affected. Therefore, using a Special Purpose Entity protects the borrower, the lender, and HUD throughout the entire loan process. SPEs are usually structured as a limited liability company (LLC), but can also be structured as a limited partnership (LP).
Comparing SPEs, LLCs, and LPs
Below are some basic details about these three entities:
SPE (Special Purpose Entity): A ‘bankruptcy-remote entity’ formed under a parent company. The purpose is isolating both the SPE and the parent company from each other’s liability and risk. SPE operation is usually limited to specific assets (like real estate). It is sometimes called an SPV (Special Purpose Vehicle). In many cases, SPE’s are also referred to as Single Asset Entities (SAEs), since they only hold one asset, in this case, a multifamily or apartment property.
Limited Liability Company (LLC): A corporate model in which only the company (the LLC) and not the owner or owners are liable for a company's debts or liabilities. It is flexible like a partnership, but limits the partners’ personal risk. LLCs are considered pass-through entities for tax purposes. Since LLC property is considered personal property of the members, it is not eligible for a 1031 Exchange.
Limited Partnership (LP): A limited partnership consists of a general partner, who directly runs the business, and one or more limited partners, who invest money but do not get involved in the day-to-day functioning of the business.
A general partner can be an individual or an entity. For example, if a HUD 223(f) borrower wanted to reduce risk even further, they could decided to have an LLC as the general partner in a limited partnership.
However, unlike in an LLC, an LP’s general partner can be held personally liable for the partnership’s risks, debts, and obligations. Limited partnerships also act as a pass-through entities for tax purposes. As the term suggests, these partnerships often have a limited lifespan.
In general, property held by an LP is considered personal property, and, like LLC-held property, is not eligible for 1031 exchanges.
What is a Special Purpose Entity (SPE) in relation to HUD 223(f) loans?
A Special Purpose Entity (SPE), also known as a special purpose entity, is a legal entity created to fulfill a narrow, or specific objective, such as owning and operating an apartment building. SPEs are typically required due to the fact that they are bankruptcy remote; if the corporation or individual who is the actual borrower declares bankruptcy, the SPE is much less likely to be affected. Therefore, using a Special Purpose Entity protects the borrower, the lender, and HUD throughout the entire loan process. SPEs are usually structured as a limited liability company (LLC), but can also be structured as a limited partnership (LP).
For more information, please see the following sources:
What are the benefits of using an SPE for HUD 223(f) financing?
The main benefit of using an SPE for HUD 223(f) financing is that it is a bankruptcy remote entity. This means that if the borrower declares bankruptcy, the SPE is much less likely to be affected. This protects the borrower, the lender, and HUD throughout the loan process. SPEs are usually structured as a limited liability company (LLC), or as a limited partnership (LP). A limited partnership has general partners, which control the partnership's financial activities, and have unlimited liability, and limited partners, which invest, but do not actively participate in the management of the partnership, and do not incur any liability. Both general partners and limited partners can themselves be corporations or LLCs in order to further reduce risk.
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What are the risks associated with using an SPE for HUD 223(f) financing?
The main risk associated with using an SPE for HUD 223(f) financing is that the SPE is much less likely to be affected if the corporation or individual who is the actual borrower declares bankruptcy. This means that the SPE can remain profitable, even if the borrower faces dire financial issues. Therefore, having an SPE owning the multifamily property protects both the lender and HUD in the case that the borrower runs into financial trouble.
What are the requirements for setting up an SPE for HUD 223(f) financing?
In order to set up an SPE for HUD 223(f) financing, the borrower must structure the legal entity that borrows the funds as a Special Purpose Entity (SPE). The SPE will then own the project itself. SPEs are typically required due to the fact that they are bankruptcy remote; if the corporation or individual who is the actual borrower declares bankruptcy, the SPE is much less likely to be affected. In addition to being an SPE, the borrower must be a single-asset entity (SAE). This simply means that the multifamily property should be the only asset that it owns. SPEs are usually structured as a limited liability company (LLC), or as a limited partnership (LP). A limited partnership has general partners, which control the partnership's financial activities, and have unlimited liability. It also has limited partners, which invest, but do not actively participate in the management of the partnership, and do not incur any liability. Both general partners and limited partners can themselves be corporations or LLCs in order to further reduce risk.
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What are the tax implications of using an SPE for HUD 223(f) financing?
The tax implications of using an SPE for HUD 223(f) financing depend on the structure of the SPE. Generally, SPEs are structured as a limited liability company (LLC) or a limited partnership (LP). An LLC is a pass-through entity, meaning that the income and losses of the LLC are passed through to the owners of the LLC, who are then taxed on their individual returns. A limited partnership has general partners, which control the partnership's financial activities, and have unlimited liability, and limited partners, which invest, but do not actively participate in the management of the partnership, and do not incur any liability. Both general partners and limited partners can themselves be corporations or LLCs in order to further reduce risk.
For more information, please consult a tax professional.