The sum of the outstanding principal balance plus increased interest may actually overstate the value of the note

A little known fact

At first glance, the fair market value (FMV) of a note, secured or unsecured, appears to be easily determined. IRS Treasury regulations assume your value is unpaid principal, plus any accrued interest and late fees as of the valuation date. To value the grade for less, satisfactory evidence must be presented. Evidence of lower valuation can be one or more factors such as: interest rate, payment amount, payment frequency, duration, collateral, payment history, or credit status of the borrower, to name a few. only some.

A qualified note appraiser can set a lower value or even a zero value of no value; the lower FMV reduces the taxable valuation of the note. This fact is not widely known, even to many CPAs and lawyers, but it is of great importance to the person who pays unnecessary taxes.

Fair market value differs from book value

Book value, cost and outstanding balance are accurate historical facts. Its accuracy is not in dispute. But, FMV (the preferred IRS definition) refers to the “market value” of the note, its current sale value, not its historical cost or unpaid balance. These two points of view result in two values ​​for the same promissory note. Only one value is adequate for tax purposes.

Defined Fair Market Value

The definition, as defined in Section 1.170A-1(c)(2) of the IRS Regulations, is “the price at which property would change hands between a willing buyer and a willing seller, without being under any obligation to buy or sell and both having a reasonable knowledge of the relevant facts”.

tax implications

A taxable event can be any of numerous events. Some examples are the sale of a note, the transfer of a note from a Traditional IRA to a Roth IRA, the gift of a note, or the need to value a note in an estate or trust. In all of these situations, the historical cost, book value, or outstanding balance of the note may differ materially from its current fair market value. Typically, the FMV is substantially less than the book value and the tax will be substantially less.

General conclusions

• The fair market value of a note is usually less than its unpaid balance plus increased interest.

• The IRS calculates many taxes on fair market value, not cost or book value.

• Many CPAs and lawyers don’t know that promissory notes are not “valued” at what they appear to be; they often overestimate the bill and overpay the tax.

• The valuation is determined based on the definition and evidence.

• A qualified and experienced note appraiser can produce a fair market value report that meets the IRS definition and regulations. The fair market value is usually less than its book value.