When and why is a promissory note appraisal required?

Determining the value of a financial asset can be an optional decision, but in most cases it is a requirement. An example of the optional category is an investor seeking to know the current market value of an asset purchased many years ago. The main driver of required or mandatory valuations is the Internal Revenue Service (IRA). All tax-related matters must be valued according to IRS rules and regulations. Let’s examine when and why notes are priced and valued.

IRS Revenue Resolution 59-60 details valuation requirements for federal income tax, estate tax, gift tax, or other tax purposes. Note appraisal and appraisal experts are needed in the following situations:

Appraisal of notes, both business and personal, for audit or tax purposes
A note is part of the financing for the sale of a business
When Wealth Managers Advise on Tax-Related Estate Planning
When estate and trust attorneys and CPAs value notes for distribution and taxes
Gift Tax Planning – “Giving”
Charitable Contribution Planning
Asset valuation of related parties (family members)
Divorce Property Asset Valuation
Valuation of company dissolution assets
Self-Directed IRA Valuation
Valuation experts are increasingly involved in working with estate and trust attorneys, auditors, CPAs, and investors. These parties need appraisals and valuations of financial assets.

Factors Affecting Note Value

The following list describes thirteen valuation factors:
1. Clarity of loan document language
2. Terms and conditions of the loan document
3. Fixed or adjustable interest rate
4. Long or short term loan duration
5. Payment Schedule: Amortization or Interest Only
6. Loan Payment History
7. Financial information and financial strength of the borrower
8. Collateral guarantee
9. Economic conditions
10. Marketability of the asset
11. Asset liquidity
12. Debt collectability
13. Risk factors

All of the above factors are individually analyzed and evaluated; then, they must be analyzed together with each other. Each of the thirteen factors can impact one or more factors. Their interrelationships affect the final Fair Market Value. Experienced judgment and training are required to reach a rational and defensible valuation conclusion.

Other cash flow financial instruments that require valuations

Notes are not the only type of cash flow financial asset that requires appraisal and valuation. Over fifty categories of non-listed financial assets require a valuation by an independent third-party appraiser. Some of the more common categories are listed below.

Deed Contracts – Installation Land Contract
Commercial Asset Secured Notes
Seller Drawn Financing/Seller Financed Note
Partial ownership of an income stream
Full ownership of an income stream
Full ownership of a balloon balance

Other Cash Flow Financial Instruments-Not Related to Notes
accounts receivable
General consumer debt
auto finance notes
rent payments
Lawsuits-commercial and consumer
credit card debt
Health and country club memberships
equipment leases
confidence advances
Retail Installation Contracts
lottery winnings
yacht notes
Annuity payments
insurance settlements
Timeshare and vacation club contracts
Inheritance and trust advances
lottery winnings
military retirement pensions
Awards and Recognition/Casino Winnings
Structured Settlements/Class Action Awards
Tax link certificates

What professional appraisal services should you expect?

A privately owned promissory note is often the centerpiece of an owner’s retirement savings; often represents a significant part of the value of the inheritance. Therefore, the expert appraiser must have real experience in the appraisal and valuation of private promissory notes. The evaluation report must be well reasoned and supported by documented conclusions. It must be an objective and defensible valuation analysis that will hold up in litigation or under IRS scrutiny.

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