If you’re looking to invest in real estate, you need to make sure that you’re protecting yourself and your assets. One of the best ways to do this is through a single purpose entity. Using a new single purpose entity for every real estate deal is recommended and often required when financing your purchases.
Here’s everything you need to know about single purpose entities in real estate, why you should use them, and how to use them:
What Is a Single Purpose Entity?
A Single Purpose Entity (SPE) is a legal entity created to satisfy an investor’s specific investment purpose. In the context of real estate transactions, an SPE is created to own and operate a particular piece of property.
The main characteristic of an SPE is that it holds the title to the real estate and operates no other assets. The two most commonly used corporate structures for SPEs are either a Limited Liability Company or (LLC) and Corporation.
Limited Liability Company (LLC)
A Limited Liability Company (LLC) is designed to protect owners from personal responsibility from liabilities like debts and lawsuits. An LLC is not required to pay taxes directly.
Instead, the members can be taxed individually based on profits and losses, thereby eliminating double taxation. And while an LLC may be relatively easy to set up and manage, the main weakness of an LLC is that the entity must be dissolved upon the death or bankruptcy of a member.
A corporation is a slightly more complicated single purpose entity that also protects shareholders from liability. In fact, corporations offer more protection than LLCs in that shareholders are not responsible for any lawsuits, debts, or other legal obligations even if the entity itself doesn’t have enough money for repayment.
There are also two different types of corporations: C corporations and S corporations. And while C corporations are considered to be the default type of corporation, S corps come with added tax benefits.
S corporations come with pass-through taxation. This means that shareholders report business profits and losses on their personal tax returns and pay accordingly. Alternatively, C corporations get taxed twice — the corporation itself pays corporate income tax, and the shareholders pay federal income tax based on dividends.
Aside from potential double taxation, the main weakness of a corporation is that it can be difficult and time-consuming to form and operate. There’s a lot of paperwork involved and regulations to follow when incorporating a business. And all this work can quickly become quite expensive.
How Does a Single Purpose Entity Differ From a Special Purpose Entity?
Both single purpose entities and special purpose entities are often referred to as SPEs, so what’s the difference between these two entities? Special purpose entities are similar in purpose to single purpose entities but are much more expansive.
For example, a special purpose entity may take the form of a Master Trust, Owner Trust, Grantor Trust, Real Estate Mortgage Investment Conduit (REMIC), Financial Asset Securitization Investment Trust (FASIT), Multiseller Conduits, Single Seller Conduits, and Domestically Domiciled Corporations.
What Are the Benefits of Owning an SPE?
Getting back to our original scenario: you are a real estate investor trying to finance a new acquisition. To apply for the loan, the lender requires that you create a new SPE. As the experienced and sophisticated investor that you are, you decide to create an SPE for this real estate transaction to reap countless benefits.
For starters, owning an SPE provides you with protection as each property will have separate SPEs. Additionally, this way, you compartmentalize each property from the others.
In other words, in the event of a lawsuit or liability claim against any of your properties, your other properties would be exempt. Furthermore, your personal assets will also be exempt.
Some SPEs can even be bankruptcy remote, meaning that the bankruptcy of the SPE would have little to no impact on the parent company. Similarly, the parent company's bankruptcy would have little to no impact on the SPE since it’s considered a separate entity.
It’s critical to note that not all SPEs are automatically considered bankruptcy remote. Instead, they have to meet certain requirements in order to be considered bankruptcy remote. For starters, the SPE must be formed for the limited purpose of owning and operating a specific property.
Additionally, it must be a separate legal entity distinct from any other person or entity while maintaining its assets separately from those of other persons and entities. Finally, it must have at least one “independent manager” who is not affiliated with the borrower and must hold no other debts besides the loan that’s secured for a specific property.
Depending on the type of SPE chosen, there are also potential tax benefits to consider. For example, with a limited liability corporation (LLC), the members are only taxed on their personal income from the entity. The taxation structure is the same with S corporations as well.
How To Form a Limited Liability Corporation (LLC)
The rules and steps for forming an LLC vary by state, so we are going to outline the process within the state of Florida:
Step 1: Name Your LLC
Start by choosing a name for your LLC. The name must include the phrase “limited liability corporation” or LLC. The name must not include any words related to a government agency. Finally, including any words like “Bank,” “Attorney,” or “University” may require extra paperwork and licensing for your LLC.
Before you finalize your name, make sure that it’s available and isn’t already in use. It’s also a good idea to make sure that there’s a suitable website URL available with the name.
Step 2: Appoint a Registered Agent
Next, you have to appoint a Florida registered agent for your LLC. This registered agent is essentially the LLC’s point of contact with the state and handles everything from tax forms to legal documents for the LLC.
This registered agent must be a full-time resident of the state of Florida or a corporation like a registered agent service that’s authorized to conduct business in the state.
Step 3: File Your Articles of Incorporation
When it comes to filing your articles of incorporation with the state, you have two options: online or by mail. It’s much easier and faster to do this online through the Florida Department of State Sunbiz website, although you can still mail your forms to the “New Filing Section, Division of Corporations” at P.O. Box 6327 in Tallahassee, FL 32314.
No matter which filing method you choose, you will also have to pay a $125 filing fee payable to the Florida Department of State.
Step 4: Create an LLC Operating Agreement
While this step is not technically required to form an LLC in the state of Florida, it’s always a good idea to create a document that outlines the ownership and operating procedures of the LLC. The purpose of this document is to keep everyone on the same page and decrease the risk of future conflicts.
Step 5: Get an EIN
Finally, you will receive an “employer identification number” or EIN for your LLC. Your EIN is issued by the Internal Revenue Service (IRS) and is used to identify the LLC, essentially the same way that a Social Security number identifies an individual.
How To Form a Corporation
Forming a corporation in the state of Florida involves many of the same components as forming an LLC. However, there are some additional steps involved in the process.
Here are the different steps that you need to follow when forming a corporation in Florida:
Step 1: Name Your Corporation
Start by choosing a name for your corporation that’s recognizably different from the names of other business entities already registered in the state of Florida. You must include the words “Corporation,” “Incorporated,” or “Company” or the corresponding abbreviations “Corp.,” “Inc.,” or “Co.”
Next, appoint a registered Florida agent for your corporation — either a business or an individual — just as you would with an LLC.
Step 3: File Your Articles of Incorporation
After that, you need to file your articles of incorporation with the Florida Department of State Division of Corporations. Make sure to include your chosen corporation name, address, purpose, number of shares. Include the names and addresses of initial officers and the agent's name, address, and signature for service or process. Lastly, add in the name and address of the incorporator.
Step 4: Create Corporate Bylaws
While you don’t technically have to create corporate bylaws or register them with the state, you want to create them to show the state government, the federal government, bankers, and creditors that your corporation is legitimate.
Step 5: Hold Board Meeting
At your first board meeting, you can formally adopt your corporate bylaws and take care of other tasks, including but not limited to issuing shares of stock, setting a fiscal year, appointing corporate officers, etc. Make sure to record corporate minutes during any and all board meetings.
Step 6: Get an EIN
Finally, you need to obtain an EIN for your corporation so that you can pay taxes. This can be completed online through the IRS website.
It is imperative that creating the SPE does not intimidate you as the process is simple, fast, and inexpensive. As your preferred lender, Vaster requires the use of SPE for any real estate loan. We like to keep it simple and beneficial for you. Please browse our loan programs for your next real estate investment.
If you are looking to invest and don't know how to start, contact us.