Quick Sale Value and Net Realizable Equity in an Offer in Compromise

Most of the dollars in a typical offer in compromise come from equity, not income. Equity is also where taxpayers and the IRS disagree most often. Knowing the specific valuation rules lets you predict the IRS number and spot where it is wrong.

The core definitions

IRM 5.8.5.4.1 defines net realizable equity (NRE) as quick sale value less amounts owed to secured lien holders with priority over the federal tax lien, and less applicable exemption amounts.

Quick sale value (QSV) is the price a seller could get when financial pressure forces a sale in a short period, usually 90 calendar days or less. The IRM says QSV is normally 80 percent of fair market value. A different percentage can be used when the market supports it, including full FMV in a market where property sells quickly at or above list price.

Real estate

IRM 5.8.5.13 tells offer examiners to establish FMV from multiple sources, such as online real estate databases, the tax assessment, comparable sales, and the recent purchase price, and not to rely on any single source. Then apply QSV.

Tenancy by the entirety. For real estate held as tenants by the entirety when only one spouse owes the tax, IRM 5.8.5.13 says the taxpayer's portion is usually 50 percent of NRE, and can be reduced below 50 percent based on the difficulty of liquidating that share when the property was not transferred to avoid collection. In the example, that would be $43,000 or less. This matters a great deal in states like Florida that recognize the tenancy; see Florida Homestead and IRS Protection.

Vehicles

IRM 5.8.5.12 uses private party value, discounted to 80 percent QSV, and then excludes $3,450 per car for vehicles used for work, production of income, or the welfare of the family: one vehicle for a single taxpayer, two for joint taxpayers.

Cash

IRM 5.8.5.7 starts with the bank balance on Form 433-A (OIC) and reduces it by $1,000 for individuals. If the checking balance fluctuates because it is used to pay monthly expenses, the examiner also subtracts one month of allowable expenses. Savings with little activity are counted at the latest balance, less the $1,000 if it was not already applied to another account.

Retirement accounts

IRM 5.8.5.10 values an IRA, 401(k), or Keogh at the cash value less the tax consequences of liquidating it and any early withdrawal penalty. Plans you cannot borrow on or liquidate until separation from employment may have no equity if you cannot reach them within the offer period. Plans you can borrow on but not withdraw from are valued at the available loan value.

The IRM also warns that large voluntary retirement contributions made after the tax was assessed, or within three years before the offer, can be added back as a dissipated asset under IRM 5.8.5.18.

Other common assets

• Life insurance (IRM 5.8.5.9): cash surrender value if you keep the policy; the sale price if you sell it; available loan value, less prior policy loans, if you borrow against it.
• Furniture and personal effects (IRM 5.8.5.11): declared value is usually accepted unless there are items of extraordinary value, reduced by the annually adjusted statutory levy exemption for individuals.
• Assets sold to fund the offer (IRM 5.8.5.4.1): no QSV discount. The examiner uses the actual arm's length sale price, less costs of sale and the expected current year tax.

Putting the example together

Add future income to get reasonable collection potential; see the RCP formula and the future income multiplier.

Where to push back

• FMV. The IRM requires multiple sources. Bring appraisals, repair estimates, or comparables if the IRS number is high.
• QSV percentage. 80 percent is the norm, but the IRM allows other percentages based on the asset and the market.
• Inaccessible funds. Retirement plans you cannot reach within the offer terms may have no equity.
• Special circumstances. The IRM notes equity cannot be zeroed just because you cannot borrow against it, but effective tax administration or special-circumstance offers can account for hardship in some cases.

Worked example: selling the house to fund the offer

IRM 5.8.5.4.1 says that when an asset has been sold, or a sale is pending, to fund the offer, the IRS does not apply the quick sale discount. It uses the verified arm's length sale price, less costs of sale and the expected current year tax. That can make the NRE higher, not lower, than the QSV method.

Take the home with an FMV of $420,000 and a $250,000 mortgage. Under the QSV method, NRE is $86,000. Now suppose the taxpayer actually sells it for $380,000, with selling costs of $26,600, and assume for simplicity that no income tax is due on the sale. NRE is $380,000 minus $26,600 minus $250,000, or $103,400. The actual sale produced $17,400 more equity than the 80 percent formula, even though the sale price was below the estimated FMV, because the IRS dropped the 20 percent discount.

Worked example: a hot market

The 80 percent figure is a default. IRM 5.8.5.4.1 allows the examiner to use QSV equal to full FMV when property is selling quickly at or above list price. For the same home, QSV at 100 percent is $420,000, and NRE becomes $170,000. That one judgment call nearly doubles the home equity in the offer. If the examiner proposes a higher percentage, ask for the market evidence behind it, and bring your own.

Worked example: a retirement plan you can only borrow against

IRM 5.8.5.10 values a plan that requires contributions as a condition of employment, and that the taxpayer cannot withdraw from but can borrow against, at the available loan value. Say a 401(k) has a $50,000 balance and the plan allows a loan of up to $25,000, with no existing loans. Equity is $25,000, not the $50,000 balance less taxes. If the plan allows neither withdrawal nor loans until separation from employment, and the taxpayer is not eligible to retire within the period used for future income, the IRM says the plan has no equity at all.

The IRM also flags the reverse problem. Large voluntary contributions made after the tax was assessed, or within three years before the offer, may be added back as a dissipated asset under IRM 5.8.5.18, even if the money is now locked in the plan. Its own example involves two years of $19,500 contributions followed by a small offer.

Keep in mind that every dollar of NRE flows straight into the offer amount, without any multiplier. A $10,000 change in a home value moves the RCP by $8,000 at 80 percent QSV. A $1,000 change in a monthly expense moves it by $12,000 or $24,000 through future income. Both sides deserve equal attention, but valuation disputes are usually where the documentation is easiest to produce.

Finally, valuation dates matter. The IRS values assets as of its investigation, not as of the date you filed the offer. If a market moves sharply while an offer is pending, expect the equity figure to move with it, in either direction.

The bottom line

The IRS values assets at 80 percent of fair market value, minus debts ahead of its lien, minus a short list of allowances. Do that math for every asset before you pick an offer amount. A realistic NRE is the difference between an offer that gets accepted and one that just extends the collection statute.