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Promissory Note Valuation – Important Tax Consequences

The sum of the unpaid principal balance plus accrued interest may actually overstate the value of the promissory note

A Little Know Fact

At first blush, the Fair Market Value (FMV) of a promissory note, 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 note 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 status to name just a few.

A qualified promissory note appraiser may establish a lower value or even a value of zero-worthless; the lower FMV reduces the note’s taxable valuation. This fact is not widely known, even 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 dispute. But, FMV (the IRS’s preferred definition) is concerned with the note’s “market value”, its current salable value, not its historical cost or its unpaid balance. These two points of view result in two values for the same promissory note. Only one value is the right one for taxation purposes.

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