Promissory observe Valuation – Important Tax Consequences

The sum of the unpaid principal balance plus accrued interest may truly overstate the value of the promissory observe

A Little Know Fact

At first blush, the Fair Market Value (FMV) of a promissory observe, secured or unsecured, appears to be easily determined. The IRS Treasury regulations presume its value to be the unpaid principal, plus any accrued interest and late charges to the date of valuation. To value the observe for less, satisfactory evidence must be submitted. The evidence for the lesser valuation can be one or more factors such as: the interest rate, payment amount, payment frequency, duration, collateral security, payment history, or the borrower’s credit position to name just a few.

A qualified promissory observe appraiser may establish a lower value or already a value of zero-worthless; the lower FMV reduces the observe’s taxable valuation. This fact is not widely known, already to many CPA’s and attorneys, but, it has great importance to the person paying unnecessary taxes.

Fair Market Value Differs from Book Value

Book value, cost, and unpaid balance owed are all accurate historical facts. Their accuracy is not in argument. But, FMV (the IRS’s preferred definition) is concerned with the observe’s “market value”, its current salable value, not its historical cost or its unpaid balance. These two points of view consequence in two values for the same promissory observe. Only one value is the right one for taxation purposes.

Fair Market Value Defined

The definition, as defined by IRS Regulation Section 1.170A-1(c)(2), is “the price at which character would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of applicable facts.”

Tax Implications

A taxable event can be any of numerous happenings. Examples are the sale of a observe, the rolling of a observe from a traditional IRA account into a Roth IRA account, the gifting of a observe, or the need to value a observe in an estate or a trust. In all of these situations the historical cost, the book value, or the unpaid balance of the observe may differ considerably from its present Fair Market Value. Usually, the FMV is significantly less than book value, and the tax will be significantly less.

General Conclusions

• The Fair Market Value of a promissory observe is usually less than its unpaid balance plus accrued interest

• The IRS calculates many taxes on Fair Market Value, not on cost or book value.

• Many CPA’s and attorneys are unaware that promissory notes are not “valued” at what they appear to be; often they over-value the observe and over-pay the tax.

• Valuation is determined based on the definition and the evidence.

• An experience, qualified promissory observe appraiser can produce a Fair Market Value report that comports with the IRS definition and regulations. The Fair Market Value is usually less than its book value.

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