How to Value a Note for Estate or Gift Tax Purposes

When you're dealing with notes—especially in the context of estate planning, intra-family loans, or gift transfers—it’s easy to assume the value is equal to the note’s principal. After all, a $1 million note is worth $1 million, right?

Not necessarily. In valuation, principal does not always equal fair market value —and the difference can have real tax consequences..

Why Notes Are Often Worth Less Than Face Value

A note's principal reflects what’s owed on paper. But fair market value is based on what a willing buyer would pay in today’s market—taking into account risk, interest rate, and liquidity.

Several factors reduce the fair market value of a note:

• Interest rate. If the rate on the note is below market, the note is worth less than face value.
• Payment terms. Deferred payments or balloon structures reduce present value.
• Credit risk. If the borrower is a family member or private entity with limited collateral, the note carries more risk—and less value.
• Marketability. Notes between family members are generally illiquid, and that lack of marketability drives the value down.
• Enforceability. Weak or informal documentation may limit the note’s legal strength.
  
  

In short, even a fully performing note with a clear repayment schedule can be worth less than its principal amount, especially in a fair market value context.

When You Need a Note Valuation for Tax Planning

The valuation gap between principal and fair market value becomes critically important when:

• You're transferring a note as a gift
• You're valuing a note for estate administration
• You're using a note in an installment sale to an intentionally defective grantor trust (IDGT)
• You're preparing for an IRS filing or audit
• You're involved in a dispute or litigation over asset values

These situations require supportable, well-documented valuations that reflect reality—not just what’s printed on the note.

How Note Valuation Discounts Affect Value

Let’s say you hold a $1 million note that pays 1% interest annually over 10 years, issued to a family member.

If the current market rate for similar risk is 6–7%, that note may be worth only $650,000–$800,000, depending on:

• Creditworthiness of the borrower
• Structure of payments
• Enforceability and documentation
• Overall market conditions
  
  The larger the gap between the note’s terms and market reality, the larger the discount—and the lower the fair market value.

How Note Valuation Discounts Are Calculated

Qualified valuation professionals typically apply a discounted cash flow (DCF) analysis to estimate the present value of the note’s future payments. Key assumptions include:

• Market interest rate (based on borrower risk and note terms)
• Discount for lack of marketability (DLOM)

• Discount for lack of control (DLOC)
  May apply if the note is part of an entity interest
  
  These inputs are backed by empirical data and market comparables to ensure defensibility.

IRS Expectations for Note Valuation in Estate Planning

The IRS expects that valuation reports consider:

• Prevailing interest rates at the time of valuation
• Creditor-borrower relationships
• Whether the note would be marketable to an unrelated party
• The legal rights and documentation supporting the note
  
  Failure to apply these principles correctly can raise red flags in an audit or trigger unnecessary tax exposure.
  
  

When to Get a Note Valuation

You should consider a formal valuation of a note when:

• You're including it in an estate return (Form 706)
• You're gifting the note or using it in a family wealth transfer
• You're restructuring family entities or conducting year-end tax planning
• You're engaged in a shareholder dispute or business divorce

Support for Defensible, Strategic Note Valuations

PCE has extensive experience valuing notes in estate planning, gift transactions, and litigation. We apply the appropriate methodologies—considering market conditions, credit quality, payment structures, and applicable IRS guidelines—to ensure your valuation is both supportable and strategic.

Whether you're a business owner, advisor, or family office, we’ll help you make informed decisions based on a true market-based view of value.