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The fair market value of a note receivable in an estate is presumed to be the unpaid principal plus accrued interest. Case law, however, makes clear that this presumption can be rebutted and that discounts may be allowed for these notes.
Much has been written on the availability of valuation discounts with respect to closely held business entities and fractional interests in real property, but an often overlooked planning opportunity is the use of valuation discounts with respect to promissory notes receivable in the taxable estate. The value of a note receivable is frequently reflected on the estate tax return at its unpaid principal balance, plus accrued interest. Nevertheless, there is ample authority permitting substantial discounts in the value of a note receivable due to changed circumstances between the date the note was issued and the date of death.
General rule for valuation of note receivable
The general rule under Section 2031 is that the value of the gross estate is determined with reference to the fair market value (FMV) of all property, real or personal, tangible or intangible, wherever situated, that is owned by the decedent on the date of death. Reg. 20.2031-4 specifically addresses the valuation of notes receivable in the estate, and states:
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 . . . If not returned at face value, plus accrued interest, satisfactory evidence must be submitted that the note is worth less than the unpaid amount (because of the interest rate, date of maturity, or other cause), or that the note is uncollectable, either in whole or in part (by reason of the insolvency of the party or parties liable, or for other cause), and that any property pledged or mortgaged as security is insufficient to satisfy the obligation.
This Regulation is the starting point for the valuation of a note and provides a presumption that notes are valued at their outstanding principal balance, plus accrued interest. However, the language of the Regulation opens the door for the executor to rebut this presumption and to...