Complete Guide to Asset Valuation for Trusts
This article will explore trust valuations, their importance, methodologies, and certain relevant valuation standards and guidelines.
In the next few years, approximately $53 trillion of assets will be inherited by younger generations from baby boomers. To ensure smooth succession, people often establish trusts for their beneficiaries.
As a result, trusts can be highly diversified across geographies and asset classes, and their valuations can be incredibly complex. This is a challenge whose ripples are felt across estate planning, tax planning, and fee calculations.
What is Trust Valuation?
Trust valuation involves establishing the value of assets held within a trust to support tax and estate planning and aligning distributions with the instructions in the deed. Such valuations can be incredibly complex, as a single trust may hold equity interests of different private concerns, derivatives, complex securities, bonds, real estate, and other kinds of assets.
It is not uncommon for trusts to be highly diversified across geographies and asset classes. Hence, valuing them would require keen financial acumen.
Why Asset Valuation Is Essential for Trusts?
Asset valuations are essential because they impact the fees paid to the trustee as well as distributions to beneficiaries. A trust is created by trustors who contribute some of their assets to be managed by a trustee for the sake of specified beneficiaries. In exchange for their services, they earn an annual fee, which is typically calculated as a percentage of the assets under administration (AuA).
In certain cases, a trustee may also be incentivized by being offered percentages of capital gains and other income generated by the trust. The trust valuation may also impact the extent of distributions to beneficiaries in a particular period.
How does trust valuation determine the fair market value of assets?
In trust valuation, the fair market value can be deduced using the following four valuation approaches.
Income approach
In the income approach, we determine an asset’s value as the present value of all the cash flows it is expected to generate. This approach is typically used when ample financial history is available to make reasonable assumptions about growth and risk.
Suppose your trust owns a company expected to generate $10 million in dividends annually for 10 years. At the end of these 10 years, the proceeds from dissolution are expected to be $4 million. Assuming a discount rate of 10%, we can calculate the value of this company as:
| Year | Income (A) | Discounting factor (B) | Present value (C=A÷B) |
|---|---|---|---|
| 2025 | $10,000,000 | 1.1 | $9,090,909 |
| 2026 | $10,000,000 | 1.21 | $8,264,463 |
| 2027 | $10,000,000 | 1.331 | $7,513,148 |
| 2028 | $10,000,000 | 1.4641 | $6,830,135 |
| 2029 | $10,000,000 | 1.61051 | $6,209,213 |
| 2030 | $10,000,000 | 1.771561 | $5,644,739 |
| 2031 | $10,000,000 | 1.9487171 | $5,131,581 |
| 2032 | $10,000,000 | 2.14358881 | $4,665,074 |
| 2033 | $10,000,000 | 2.357947691 | $4,240,976 |
| 2034 | $10,000,000 | 2.59374246 | $3,855,433 |
| 2034 (Proceeds from dissolution) | $4,000,000 | 2.59374246 | $1,542,173 |
| Asset value | $62,987,844 |
Market approach
In the market approach, we observe how similar assets are being valued by the market to estimate how it will value the asset in question. In the context of company valuations, the comparable company valuation method and the market valuation multiple method are two techniques that come under this approach.
Suppose your trust owns 20% of a record label with an annualized revenue of $100 million. By researching similar record labels, you arrive at a revenue-based market valuation multiple of 12.
Then, you can calculate the value of your trust’s stake in the record label as:
| Particulars | Amount |
|---|---|
| Annualized revenue of the record label | $100,000,000 |
| Revenue-based market valuation multiple | 12 |
| Record label valuation (C = A × B) | $1,200,000,000 |
| Ownership percentage | 20% |
| Value of stake (E = C × D) | $240,000,000 |
Asset approach
In the asset approach, the net asset value is assigned as a company’s valuation. This approach is appropriate for early-stage companies, real estate companies, holding companies, companies nearing dissolution, and any capital-intensive companies with more tangible assets than intangible assets.
If a company’s balance sheet shows total assets of $430 million and total liabilities of $260 million, it will be valued at $170 million, i.e., its net asset value.
Cost approach
Here, an asset’s valuation is determined as the cost to rebuild said asset. So, in addition to direct costs such as materials and labor, you must consider engineering, legal, and other indirect costs while also accounting for depreciation, if the cost estimates are dated.
Suppose one of the companies owned by your trust is heading for dissolution, and you need to know the value of its assets. The key asset of this company is its plant and machinery. Building these assets involved the following costs 2 years ago:
- Capital goods = $3 million
- Materials = $1 million
- Labor = $500,000
- Engineering = $160,000
- Compliance and regulatory expenses = $80,000
Assuming a 10% straight-line depreciation, we can calculate the value of the plant and machinery as:
| Particulars | Amount |
|---|---|
| Capital goods | $3,000,000 |
| Materials | $1,000,000 |
| Labor | $500,000 |
| Engineering | $160,000 |
| Compliance and regulatory expenses | $80,000 |
| Value of asset 2 years ago (F = A + B + C + D + E) | $4,740,000 |
| Depreciation over 2 years (G = 2 × 10% × F) | $948,000 |
| Present value of the plant and machinery (H = F – G) | $3,792,000 |
Standards and guidelines for accurate trust valuations
When you are performing trust valuations, you must be mindful of the following standards and guidelines:
- ASC 820 – Fair Value Measurement standard – This accounting standard lays down the framework for reporting fair values whenever required under other accounting standards.
- Section 2702 of the Internal Revenue Code – Special Rules for Trust Transfers – Under this Section, certain trust interest transfers would be valued at 100% of the trust interest holdings of the transferor. This maximizes the gift tax instances.
- IRS standards and guidelines – Certain IRS revenue rulings and treasury regulations, such as Revenue Ruling 59-60 and Treasury Ruling 2031-1, include important trust valuation guidelines for the purpose of tax reporting.
Eqvista – Compliance through accuracy!
The nature of trust valuation exercises changes drastically depending on the purpose. Your valuation methodologies might produce accurate results for performance tracking. However, you may need to navigate a complex web of accounting standards, revenue rulings, and treasury regulations to ensure tax compliance.
Eqvista’s experienced and highly qualified valuation team can deliver accurate and in-depth valuation reports and help you tackle compliance challenges effectively. Contact us to learn more about our services!
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