When a promissory note is used for estate planning purposes, or is included in an estate, it is often necessary to determine its Fair Market Value, which is the price at which the property would exchange hands between third parties without any compulsion to buy or sell the promissory note. With regard to promissory notes, Treasury Regulation §20.2031-4 notes the following:

§20.2031-4 – "The fair market value of notes, secured or unsecured is presumed to be the amount of unpaid principal, plus interest accrued to the date of death, unless the executor establishes that the value is lower or that the notes are worthless."

In our experience, privately held promissory notes can be valued at discounts ranging from 0% to 45% or more, depending on the terms of the note.

Many times, a promissory note originates from a related party in exchange for the purchase of an interest in a family business or partnership. Several complex valuation questions may arise, such as: 

·     Is the promissory note worth the current balance due or is the market value equivalent to something less than the outstanding balance?  

·     What is a reasonable market-based interest rate for a privately held promissory note?  

·     Should the reasonableness of the appraisal be determined by the size of the resulting discount on the promissory note or by evaluating the market rate of return of the investment?  

How does one know if the business valuation report of a promissory note being reviewed can hold up to the scrutiny of the Internal Revenue Service?