The bankruptcy-remote entities are used to limit the project’s financial risk. They are widespread in the case of multifamily and commercial real estate properties. They have become a primary requirement for many lenders.
Many people associated with the industry need to be made aware of the importance of the same. If you are a newbie in CRE and are hoping to get a loan, then a proper understanding of the same will be beneficial for you to make the most of the available opportunities.
The guide here will provide you with clear-cut information about the same.
Bankruptcy remote entity- What is it?
It is a legal entity structured in a format that if the parent company is declared bankrupt, it will not affect the financial status of the borrowing entity. This helps protect the lenders, borrowers, and the HUD from any unexpected financial complications.
However, there can be a significant downside. When the property loses money, the borrower cannot put cash into it to save it from foreclosure.
Bankruptcy remote entities used in a multifamily
This entity protects the investors or lenders associated with the multifamily sector. From an investor’s point of view, this will guarantee that the bankruptcy of another partner will not impact the property’s investment in any way.
To understand things better, here is an example for you. Let’s consider Michelle and James to be a partner on a multifamily investment with 50/50. They have a market value of about $1 million.
Now James needs to catch up on a personal home loan with $650,000 and thus is declared bankrupt. His assets are there used to clear the debt.
The impact it will have on the multifamily properties will depend if the ownership and trust in the apartment building are valid for a bankrupt remote entity. If it happens, it will be protected, and Michelle will have significant relief.
Simply put, the remote bankruptcy equity will be a relief for all multifamily lenders for the same reason. When the small apartment building is tied to a multifamily loan, liquidating the assets will mean the lender will not earn a total return on loan.
In fact, they can even end up making losses. For this reason, the BREs are primarily used in multifamily transactions to separate the assets from the individuals. Thus, it helps protect it from any personal bankruptcy issue the investor can face.
Which loans will use BRE?
There are a large number of lenders who require borrowers to make use of the BRE to qualify for the loan. It is due to the results mentioned above. The following states the non-exhaustive list of financing types typically requiring BRE.
- Fannie Mae loans
- USDA loans
- HUD multifamily loans of all types
- Freddie Mac loans
- CMBS loans
- Bank and credit union loans
- Life Company loans
Various other financing types will also require the borrower to own no other assets through the entity. This means they will generally be single-asset entities.
Building a remote bankruptcy entity
If you want to create a BRE for your multifamily investment, follow the five steps below. But remember, most states have a different process. So it would be best if you enquired about it in advance.
- Name the legal entity
You must know that all legal entities must be registered at the state level. So it would be best if you chose a name for your LLC that fits well with the business requirement of your state and is not yet taken. For the same, you can check your selected name’s availability through the online business search function. It is available in almost all states.
- Create a holding structure
You must file for the articles of organization with the business registration office of your state. This will generally come with a certain amount of fee.
The report must include the language indicating that the LLC is being formed as a remote bankruptcy entity and will comply with the laws governing BREs of the state.
In addition, it must be a significant part of the holding structure that will separate the property ownership from the BRE.
One way is through the LLC, which will allow multiple properties to be held in separate series or cells. But some of the lenders might permit differently.
You need to understand things better to make the right decision and choose a lender who works with you for your benefit.
- Draft the opening agreement
When drafting an operating agreement, it must not include any provisions that will make it difficult for the BRE owners to file for bankruptcy or to indicate how bankruptcy has affected the BRE’s operations.
This can include restrictions on the owner’s ability to transfer ownership or assets requirement for maintaining certain capital levels, limitations on dividends and distributions, etc.
It will be helpful that you understand the essentials right in advance to make the right decision about your draft. Make sure that you pay attention to it and come up with something that will be beneficial for your needs and will ensure you can get the best results.
- Get professional advice
BRE can be highly advantageous, but filing it can be a bit tough. So considering help from a good professional will be helpful to get the proper support to ensure that your plan follows all the BRE regulations.
It would be best if you got a third-party professional’s financial and legal opinion. It will ensure that your LLC has been started correctly, and it will protect it from the bankruptcy risk of the owners.
- Register for taxes
You must register your LLC for both federal and state taxes. This can include everything from obtaining an employee identification number to the internal revenue services. Even if you do not directly employ anyone through the entity, you must register for the same.
What are the benefits and risks?
There are a lot of benefits when you choose to set up a remote bankruptcy entity. This will include everything from protecting the lender, borrower, and the HUD from any unexpected financial complications. This is because if the following parent company entity declares bankruptcy, it will not affect the financial status of the borrowing entity itself.
Further, the risk associated with the bankruptcy remote entity is that if the property is losing money, the borrower cannot inject the cash into the property to save it from foreclosure. However, they might get a HUD 223(d) operating laws loan to inject money into the property. Thus, it will help get better stabilization.
What is the tax implication of a bankrupt remote entity?
The tax implication for depend entity will depend on the type of entity and the jurisdiction where the property is located. Generally, the bankruptcy remote entity will separate the legal entity for tax purposes. It will mean that the taxes will be subjected to their tax obligation.
For instance, a bankrupt remote entity can be subjected to federal, local, federal, and state income tax. Besides, the entities can also be subjected to other taxes like sales, payroll, and property taxes. So you must consult a good tax professional to understand the tax implications to use it correctly and enjoy all the benefits.
Cost of bankruptcy remote entity
The cost of creating BRE can vary significantly from one state to another. It is expected to pay an upfront fee for the registration of the LLC. It will be between $50 to $100. Also, there will be recurring costs to keep the operations active. However, not all states require this. You might also have to pay small fees. It will be less than $50 to reserve a name for the LLC.
It would be best if you had a fair idea about the same to complete the process as soon as possible. This will make things less complicated.
Consider getting professional support if you want to use BRE for your business. Private Capital Investors are one of the most trusted ones to get the help you require for creating and managing BRE.
We have got experienced professionals who understand the process well. They will provide you with the best support possible. Irrespective of your complications, the expert will make the job absolutely comfortable for you.
We will maintain complete transparency and help you understand things better. With their professional support, you will easily create your BRE. Also, you will learn something in the right way. So better connect with them to get the professional help you require.