Promissory Notes and Mortgage Notes May Provide Tax Deductions

Fair Market Value of Promissory Notes May be A Stealth Tax Deduction

Looking for Tax Deductions

Promissory notes and mortgage notes have two primary values-cost value and Fair Market Value. The cost value is what you paid, or what you invested; Fair Market Value is what the note is worth today if it were sold. If $10,000.00 was invested in a note originally, and today its Fair Market Value is zero ($0.00), there may be a $10,000.00 tax deduction available, depending on the specific facts. This tax deduction will happen if and when you take steps to make it happen. The burden is on you.

The promissory note and mortgage note may be held in a self-direct IRA account, Roth IRA account, estate account, or in a trust account. The note may have been a business note, or a note from a friend or family member. It may be in safe deposit box. The note may have lost value, or may be worthless; it may qualify for a tax deduction. Since most taxpayers file tax returns at year-end; now is the time to look for these “stealth tax deductions. The burden is on you.

What is the Reason for the Tax Deduction?

The U.S. Treasury Regulations (IRS) requires valuing promissory notes, at their FAIR MARKET VALUE, not at cost.

Sec. 20.2031-4 Valuation of notes

The fair market value of notes, secured or unsecured, is presumed to be the amount of the unpaid principal, plus interest accrued to the date of death, unless the executor establishes the value is lower or that the notes are worthless. However, items of interest shall be separately stated on the estate tax return. 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 uncollectible, 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 cannot satisfy the obligation.

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Who Must Do the Fair Market Value Appraisal?

To determine The Fair Market Value of a private party promissory note or mortgage note, an appraisal or valuation report must be prepared by a qualified, experienced appraiser.

Qualified Appraiser Defined – A qualified appraiser has earned an appraisal designation from a recognized professional organization or has otherwise met minimum education and experience requirements under IRS regs; regularly appraises for compensation; and meets any other such requirements prescribed by IRS (Code Sec. 170(f)(11)(E)(ii)). An individual won’t be considered a qualified appraiser for any appraisal unless he demonstrates verifiable education and experience in valuing the type of property subject to the appraisal, and hasn’t been prohibited from practicing before IRS at any time during the three-year period ending on the date of the appraisal (Code Sec. 170(f)(11)(E) (iii)).

What Factors Affect Fair Market Value?

• Collateral security–lack of collateral security, no collateral, or too little collateral

• Credit score information, financial and employment information for the borrower

• Credit scores, financial information and employment information is negative

• Lender’s Title Insurance Policy–not having it

• Written payment history schedule-not having it

• Poor payment history

• Interest rate too low

• Duration of the loan too long

• Payment amount too small or too infrequent

Individually and collectively these impairments and deficiencies reduce the Fair Market Value of a promissory note. An arms-length, third-party buyer will discount the purchase price of the note significantly to compensate for any and all of these deficiencies.


– Depending upon the individual facts, the discounts applied can range from 5% to 90%.

– Any discount may contribute to a tax saving and a fee saving.

– Always consult and work with an experienced tax expert and promissory note expert.

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