How private business and investment interests are valued

Start with the valuation date

Property gifts use the value on the gift date. Estate property ordinarily uses fair market value at death, unless the executor elects alternate valuation under the conditions below.

The election covers all gross estate property. It must decrease both the gross estate’s value and the combined estate tax and applicable generation skipping tax on gross estate property, after allowable credits.

Property distributed, sold, exchanged or otherwise disposed of within six months after death uses its disposition date. Retained property uses the date six months after death.

An interest affected by mere lapse of time retains its death date value, adjusted for other changes in value. The executor elects on the estate tax return, and the election is irrevocable.

The election is unavailable on a return filed more than one year after its filing deadline, including extensions.

Choosing valuation approaches

IRS business valuation guidelines identify asset based, market and income approaches and call for considering all three. These guidelines address IRS personnel engaged in valuation practice.

Under those guidelines, professional judgment selects the approaches and methods that best indicate the business interest’s value. They do not establish a binding taxpayer appraisal requirement or assign a method solely from an entity’s label.

Match financial inputs to the method

The same IRS guidance calls for analyzing historical financial statements and adjusting them where necessary to reflect asset values, income, cash flows or benefit streams consistent with the selected valuation methodology.

Discount rates, capitalization rates and multiples must be consistent with the selected benefit stream within that methodology.

Evaluate control and marketability without counting them twice

The IRS guidance calls for separately considering marketability and control when appropriate for the assignment, if those factors were not already considered in determining and weighing other indications of value.

Marketability considers the business, ownership interest or security, relevant contractual and legal restrictions, and market conditions. Control concerns the particular interest’s ability to control business operations, sale or liquidation.

These considerations do not establish an automatic discount or percentage.

A contractual price does not automatically control

Federal transfer tax valuation generally disregards rights to acquire or use property below its fair market value determined without those rights. It also generally disregards restrictions on selling or using property.

An exception requires all three conditions:

• The arrangement is a bona fide business arrangement.
• It is not a device to transfer property to the decedent’s family for less than full and adequate consideration in money or money’s worth.
• Its terms are comparable to similar arrangements between persons dealing at arm’s length.

Estate return records and discount disclosures

For a decedent’s partnership or unincorporated business interest, estate tax return instructions require attached assets and liabilities statements for the valuation date and the five preceding years.

They also require net earnings statements for those five years and the entity’s EIN. The valuation must account for goodwill.

These requirements concern those business interests, rather than every private asset. Business valuations also require supporting financial and technical data.

If Form 706, Part IV, line 11b is answered yes for a partnership, unincorporated business, LLC or closely held corporate stock interest, attach the required Schedule F discount statement.

The statement identifies the Schedule F line number, item number and total effective discount taken on the interest.

Two related terms

Fair market value: The price at which the particular property interest would change hands between a willing buyer and willing seller, neither compelled to transact and both reasonably informed of relevant facts. A forced sale price does not establish it.

Lack of marketability discount: A valuation reduction for limited marketability depends on the particular interest’s facts. The discount examples in estate tax return instructions do not establish an available percentage.

EstatePlanner.com resources to open next

• Private assets and real estate records checklist

  Use this checklist to organize the private interests you want to discuss alongside this guide’s valuation questions. Bring it to a conversation about the interests your family owns.

• Business succession records and questions checklist

  Open this when the valuation discussion also raises questions about the business’s future. It gives the succession conversation its own place alongside your valuation work.

• Estate administration records and questions checklist

  If you are gathering information after a death, use this resource for the broader administration discussion. Keep this guide nearby for the valuation records described above.

• What qualifies for farm and business special use valuation

  Open this separate guide if your next question concerns special use valuation for farm or business property. It covers eligibility rather than the valuation approaches discussed here.

An investor’s perspective on cash flow

In a discussion of real estate and municipal bonds, the speaker connects an asset’s value with its underlying cash flow.

"Well, if you're in real estate, you know that we value, an asset based on its cash flow. We take the NOI, we divide it by a cap rate, and that tells us the value of that asset. Well, what you're really valuing is the cash flow stream from that asset."

Common questions