Get Tax Deductions for Non-Cash Donations Asset-Promissory Note Donations
Illiquid Financial Assets
Financial assets that are difficult to sell because of their cost, lack of interested buyers, or other reasons are called “illiquid”. Examples of illiquid assets include: Limited and personal shares, LLC’s and limited partnership interests, deed 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, are very high, but it is difficult to price and sell them.
The absence of liquidity reduces the value of the asset by the amount of the liquidity discount. All other things being equal, the less liquid the asset is, the less it is worth. Measuring these discounts and applying them in the valuation of illiquid assets has always been a challenge.
A Tax Efficient Way to Make a Charitable Difference
Many charities welcome contributions from illiquid assets. For donors, this may be an effective and tax efficient method of giving. Donors are entitled to claim a tax deduction from fair market value– not just an initial cost basis. This tax treatment offers significant benefits at the federal level and often at the state and local levels as well.
Key Considerations of Donated Property
Donors must obtain a qualified independent assessment before making a contribution. The IRS requires donors to obtain a qualifying assessment for illiquid assets no earlier than 60 days before the gift date and no later than the maturity date. It is the responsibility of the Donor to obtain an assessment, file an appropriate tax return, and defend against any challenge to a claim for tax benefits.
The tax consequences are important. Donors should consult a professional tax advisor. The tax benefits of an unusual (illiquid) gift may be substantial – and can include a reduction in the full fair market value of the asset, avoidance of all capital gains taxes, and the ability to make withholdings for six years. But, the devil is in the details; it has to be done right, according to IRS rules.
Setting “Fair Market Value” for Promissory Notes
“Fair Market Value” is the price at which the property would change hands between a willing buyer and a willing seller, not under duress to buy or sell and both having reasonable knowledge of the relevant facts. To trade liquid assets in an active market, valuations must reflect observable quotes, recent transactions, or primary issue prices for identical assets.
For illiquid assets, if the actual price cannot be determined due to poor liquidity and lack of trading activity, an alternative approach is required. The valuation of a qualified appraiser must reflect a “Fair Market Value” that approximates the actual value of the sale in a hypothetical and orderly transaction.
Assessors should use experienced judges; that is the key to valuing illiquid assets. No math formulas, rule of thumb calculations, or textbook processes; it is the “Judgment Process”. This requires a good understanding of the promissory note and its potential buyers.
Valuing an asset requires determining the appropriate rate of return applicable to the note being valued. This decision is based on an individual, unique risk/return profile. Benchmark yield rates used for comparison must be closely related to current and/or historical results for comparable assets. This means that valuation specialists must have expertise and understanding across multiple disciplines, including trading, quantitative research, credit analysis, and structured finance.
Conclusion
Donating illiquid assets, such as personal promissory notes, can be an efficient tax plan.
Tax deductions for donating non-cash assets, such as promissory notes, can be very valuable. The devil is in the details; it has to be done right, according to IRS rules.
