Accounting Rate Of Return Is Based On Cash Flow Illiquid Assets – Donating and Appraising Promissory Notes, A Tax-Efficient Plan

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Illiquid Assets – Donating and Appraising Promissory Notes, A Tax-Efficient Plan

Get tax deduction for donating a non-cash asset-promissory note

Illiquid financial assets

A financial asset that is difficult to sell due to its cost, lack of interested buyers or some other reason is called “illiquid”. Examples of liquid assets include: restricted and private stock, LLC and limited partnership interests, deeds and mortgages, promissory notes, mineral rights including oil and gas partnerships, royalties, existing trusts, insurance policies and real estate.

Illiquid assets have value, and in many cases, much higher value, but are difficult to price and sell.

Absence of liquidity reduces the asset’s value by the amount of the liquidity discount. All other things being equal, the more liquid an asset is, the lower its value. Measuring this discount and applying it to real estate valuation has always been a challenge.

A tax-efficient way to make a charitable difference

Many charities welcome contributions of liquid assets. This can be an effective and tax-efficient method of giving for the donor. The donor is entitled to claim a tax deduction of the fair market value–not just the original cost basis. This tax treatment offers significant benefits at the federal level and frequently at the state and local levels.

Donated Property-Key Considerations

Donors must obtain a qualified independent appraisal before contributing. The IRS requires the donor to obtain a qualified appraisal for non-liquid assets 60 days before the date of the gift and no later than the due date. It is the donor’s responsibility to obtain an assessment, file a proper tax return and defend against any challenges to claims for tax benefits.

The tax implications are important. Donor should consult a professional tax advisor. The tax benefits of making an unusual (illiquid) gift can be significant – and can include deducting the entire fair market value of the property, avoiding all capital gains taxes and the ability to carry forward the deduction for six years. But, the devil is in the details; It should be done properly according to IRS regulations.

Establishing “Fair Market Value” for a Promissory Note

“Fair market value” is the price at which the property would change hands between a willing buyer and a willing seller, with no compulsion to buy or sell and both having reasonable knowledge of the relevant facts. For liquid assets trading in active markets, valuations should reflect observable prices, recent transactions or primary issue prices for similar assets.

For illiquid assets, if actual prices cannot be established due to poor liquidity and lack of trading activity, an alternative approach is required. A qualified appraiser’s appraisal must reflect “fair market values” that represent actual values ​​estimated from sales in a hypothetical, orderly transaction.

The appraiser must use experienced judgment; This is the key to valuing liquid assets. There are no mathematical formulas, rule-of-thumb calculations or textbook procedures; This is a “due process”. It requires a good understanding of the promissory note and its potential buyers.

Valuing the property requires determining the appropriate yield rate of return applicable to the note being appraised. This decision is based on his individual, unique, risk/return profile. Benchmark yield rates used for comparison should closely correlate with current and/or historical yields for comparable properties. This means that valuation specialists must have expertise and understanding in a number of disciplines, including trading, quantitative research, credit analysis and structured finance.

conclusion

Donating liquid assets such as private promissory notes can be a tax efficient plan.

The tax deduction for donating a non-cash asset like a promissory note can be very valuable. The devil is in the details; It should be done properly according to IRS regulations.

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