What Is Fair Market Value (FMV)?
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Why Is the FMV Important?
The fair market value is important for many things, but it is crucial information for investors, especially in real estate. Investors need the FMV to arrive at a fair and equitable price for an asset (in this case, property) to be traded.
In general terms, the Internal Revenue Service defines the FMV as:
“The fair market value is the price at which the 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.”
For an FMV to be as objective as possible, it should be determined under the following conditions.
- Both parties have adequate information relevant to the asset.
- The parties are acting in their best interests.
- There is no undue pressure on both parties for the deal on the asset to proceed.
- They have a reasonable time to complete the transaction on the asset.
If these conditions are met, the fair market value of an asset should represent an accurate assessment or valuation of its worth.
What Is the FMV Used for?
FMV is commonly used in real estate deals, taxation, salary negotiations, and business sales. In real estate, the fair market value is essential information for flippers so they can determine the home improvements needed to achieve a fair market value. In addition, property tax is based on a property’s FMV, which is essential for tax planning purposes.
Determining the fair market value of assets is also vital when addressing the following:
- Legal issues. The FMV is useful in asset valuation for settlements arising from a divorce, partition of inherited properties, or payment of damages due to the harm done to private property.
- Insurance claims. Fair market value comes into play in insurance claim cases. For example, the insurance claim on a damaged car is proportionate to its FMV, not its original purchase price.
- Asset depreciation. Fair market value can calculate how much an asset has depreciated over the years.
- Taxation. FMV is the basis used in computations on municipal taxes and tax deductions on assets donated to charity.
FMV is also helpful when comparing prices. For example, a large difference between the FMV and the market price can show if a planned purchase will be at a premium or a discount.
FMV vs. Other Asset Valuations
Some individuals confuse FMV with other types of asset valuations, such as market value. Here are some similar terms that get confused or conflated with FMV.
FMV vs. Market Value
The difference between FMV and market value is that the FMV is a hypothetical value, determined based on the estimated amount that a buyer and seller will likely agree upon under the conditions mentioned above.
On the other hand, market value is the price at which an asset will actually sell in the marketplace.
FMV vs. Appraised Value
This difference is principally important in real estate discussions. While both valuations determine the worth of a property or business in a free market, the appraised value or appraisal is the best estimation of a third-party professional appraiser on how much the asset is worth.
FMV vs. Market Price
FMV should not be confused either with an asset’s market price. The market price is the current price of an asset listed on the market, indicating how much it can be traded for. The forces of supply and demand, among other market forces, determine the market price.
Similarly, fair market value does not equate with the term “normal price,” which results from demand and supply for long periods of time.
How to Calculate FMV
Four approaches can be used to assess fair market value.
1. Selling Price
The price of an asset bought or sold recently can be a good FMV indicator. For instance, averaging a publicly traded company’s stock using its lowest and highest selling price in one trading day is one way to determine FMV for that stock.
2. Sales of Comparable Assets
This approach is most common in the fair market valuation of real estate. This approach uses the selling price of similar properties (called “comps” in real estate parlance) to a target property to determine the latter’s hypothetical value.
3. Replacement Cost
Insurance claimants can use the replacement cost approach when performing a fair market valuation. This approach is based on the cost of buying or building a similar property or asset. It can also be used when preparing a tax return.
4. Expert Opinion
This approach relies on a professional appraiser who will determine the value of an asset or a property. In this case, the fair market value is deemed as an expert’s unbiased opinion. A fair market value determined this way is synonymous with appraised value.
BY THE NUMBERS: There is an estimated 78,015 active real estate appraisers in the U.S.
Source: Appraisal Institute
- Fair market value refers to the hypothetical value of an asset that a seller and buyer will likely agree on, based on their relevant knowledge of the asset and while acting in their best interests.
- FMV can be conflated with other terms, most commonly market value. However, FMV is only a hypothetical value; the market value is the price at which an asset will actually sell for.
- There are several ways to assess the fair market value of any asset. In real estate, one such way is to look at comps (properties similar to a target property) and their selling price on the market.
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