Fair market value refers to the price at which a business, property or other asset would sell in an open, competitive market. Here, both the buyer and seller have access to relevant information, adequate time to complete the transaction and no pressure to buy or sell. They act independently in their best interests, mutually agreeing on a fair price. This concept is widely used in real estate and tax contexts. But it also applies to salary negotiations, business sales and other transactions where setting a fair and reasonable price is essential for all parties involved.
Do you have questions about the fair market value in your situation? Speak with a financial advisor about it today.
Assessing Fair Market Value
There are four basic methods of determining fair market value. They go as follows:
- Cost or selling price: If the item has been recently bought or sold, that can be a good indicator of its fair market value.
- Sales of comparable assets: When a real estate agent presents a prospective home seller with a list of recent sales prices for similar nearby homes, known as comparables, this is a way of determining fair market value.
- Replacement cost: This may come into play when settling an insurance claim, as well as preparing a tax return. It refers to what it would cost to buy or build a similar property or asset.
- Expert opinion: When you hire a professional appraiser to give you a value on a piece of property, the resulting figure will be the fair market value, in this expert’s opinion.
Common Uses of Fair Market Value
Fair market value is often used to determine the worth of tax-deductible donations. The IRS advises against using a rigid formula for this assessment, emphasizing that factors such as an asset’s appeal, functionality and rarity, along with the time elapsed between acquisition and donation, should all be considered.
Local property tax assessments often rely on fair market value evaluations to estimate property worth. This measure is also essential in divorce cases where real estate needs to be sold or divided.
Additionally, fair market value plays a crucial role in insurance claims, bankruptcy proceedings, mortgage applications and estimating any taxes due on inherited property.
Challenges of Assessing Fair Market Value
There’s no single way of determining fair market value that’s the best for every situation.
For instance, if you bought a car from someone who was forced to sell quickly because of an imminent job transfer oversees, you may have paid well below fair market value. If later you decide to donate the car to charity, you may be able to claim a deduction that’s more than the price you bought it for.
Similarly, the accuracy of a real estate agent’s comparables depends on using recent sales of closely comparable properties. Using replacement cost requires accurately estimating costs as well as accounting for depreciation and other factors. Finally, an appraiser’s estimate of fair market value is only as good as the appraiser’s expertise and the completeness of the information available.
Eminent domain is another area where fair market value is often not relevant, because the person losing his or her property is under compulsion.
Determining fair market value is especially difficult when it comes to unique items such as art and handmade items because there may be few or no comparables. And the notably tricky science of making forecasts about the future often comes into play when valuing a business. This is because the value today may depend on the future cash flow over the next several years. Ultimately, fair market value is only an estimate.
It also important not to confuse fair market value with intrinsic value, or market value. When determining market value, the intent is generally to put an asset up for sale and, ultimately, complete the transaction. Fair market value is more hypothetical and an actual sale and change of ownership isn’t always anticipated.
Bottom Line
The fair market value is the price at which a property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts. It’s widely used in many financial arenas, especially in tax matters and real estate deals. But it’s also used by auction houses and in online for-sale postings. While the basic idea is simple enough, depending on circumstances, different sources and tools for estimating this value may produce widely varying numbers.
Tips on Fair Market Value
- Consider working with a financial advisor if you need to determine fair market value for tax, real estate, sale of a business or other purpose. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area. You can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Assessing the value of a property for the purpose of paying taxes can be difficult. However, an easy-to-use property tax calculator can give you a quick idea of how much you owe the government.
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