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A woman assesses fair market value

Fair market value is the price a business, property or other asset would sell for in an open and competitive market where buyer and seller have adequate information of relevant facts, a reasonable time to complete a deal, under no compulsion, are acting in their own interests and mutually agree on the price. Fair market value is common in real estate and tax matters, but it is also used in salary negotiations, business sales and many other transactions, all of which hinge on coming up with a price that seems reasonable to the concerned parties. Here’s how it’s determined, factors that can make such a determination challenging and some common uses for it.

Assessing Fair Market Value

There are four basic methods of determining fair market value.

  • 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

Divorcing couple splits house valueOne of the most common areas where fair market value is used is in gauging the worth of tax-deductible donations. The Internal Revenue Service warns against taking an overly formulaic approach to this task. Factors such as an asset’s desirability, use and scarcity must be considered, as well as the difference in time between an asset’s acquisition and its donation.

Assessing the value of a property for the purpose of local property taxes typically entails gauging fair market values. Fair market value is also used in divorce proceedings when real estate must be sold or divided.

Insurance claims, bankruptcies, mortgage applications often require the use of fair market values, as does estimating any taxes that may be due on inherited property.

Challenges of Assessing Fair Market Value

There is no single way of determining fair market value that is always best for all situations.

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 is 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 well 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, 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.

The Bottom Line

Wooden blocks spelling the word "FAIR"

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 fair market value may produce widely varying numbers.

Tips on Fair Market Value

  • Consider working with an experienced financial advisor if you need to determine fair market value for tax, real estate, sale of a business or other purpose. Finding the right financial advisor who fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with a local advisor who will 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.

Photo credit: ©iStock.com/Eva-Katalin, ©iStock.com/AndreyPopov, ©iStock.com/Andrii Yalanskyi

Mark Henricks Mark Henricks has reported on personal finance, investing, retirement, entrepreneurship and other topics for more than 30 years. His freelance byline has appeared on CNBC.com and in The Wall Street Journal, The New York Times, The Washington Post, Kiplinger’s Personal Finance and other leading publications. Mark has written books including, “Not Just A Living: The Complete Guide to Creating a Business That Gives You A Life.” His favorite reporting is the kind that helps ordinary people increase their personal wealth and life satisfaction. A graduate of the University of Texas journalism program, he lives in Austin, Texas. In his spare time he enjoys reading, volunteering, performing in an acoustic music duo, whitewater kayaking, wilderness backpacking and competing in triathlons.
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