## How Is Fair Market Value (FMV) Determined?

fair market value (FMV) is an assessment of an asset’s value or worth. It’s often used in tax law and the real estate market. The method for calculating FMW will vary based on your objective—for example, if you are buying a building, your objective will be to pay less than fair market value. And if you just bought real estate and want to flip the property, the FMV may determine the sale price.

Municipal property taxes are often assessed based on the property's FMV. Depending on how long you've owned the home, the difference between the sale price and the property’s FMV can be substantial.

## Calculating Fair Market Value

Fair market value is generally calculated in one of four ways—the cost of the item, comparable property sales, replacement cost, or expert opinion.

The cost of an item is often, but not always, the FMV—assuming you recently bought it in an arm's-length, fair transaction. The more time since the purchase, the increased likelihood that the market may have changed. Some items, such as old furniture, are rarely worth the original cost unless they're antiques. Additionally, when selling equipment that has been in use for years, depreciation should be considered, as well as aging and wear-and-tear. All of these will reduce FMV beneath the original sale price of the asset.

For real estate, comparable property sales are commonly used to determine FMV. This method looks at similar properties—or comparables, or "comps"—that have sold in recent months. This standard is less reliable if the market changes quickly, or if the recent sales aren't similar enough to the property. A two-bedroom home won't help you price a three-bedroom; a split-level isn't comparable to a ranch.

The replacement cost of buying a newer model of the item likely doesn't represent the fair market value, but it does set an upper limit. If, say, you’re replacing a five-year-old computer, the old model is probably worth substantially less than the one being bought.

Then there’s the expert opinion. This method of calculating FMW is valuable if dealing in something collectible or if there are no good comparables. If a company is making a sizable non-cash donation to charity, the IRS may require an appraiser's opinion to back up the fair market value claimed.

### FMV special cases

If setting fair market value affects an individual's income taxes, the IRS may have specific guidelines to follow. For instance, if a small business owner provides employees with a company car as a benefit, the IRS formulates several methods of FMV calculations, such as the standard mileage rate multiplied by the number of miles in a given year.

FMV is also often used in the insurance industry. For example, when an insurance claim is made after a car accident, the insurance company covering the damage to the owner's vehicle usually covers damages up to the vehicle's FMV.

## Why Do I Need to Know the FMV?

The FMV is the price that assets sell for...

• On the open market
• From a willing seller
• Performing in both parties' best interests
• Free of undue trade pressure
• Given a reasonable time period for completing the transaction.

With these conditions in mind, an asset FMV should represent an accurate valuation or assessments of its monetary worth.

"Fair market value" is typically used in legal settings. For instance, FMV in real estate is predominately used in divorce settlements and when calculating compensation from a government taking advantage of eminent domain. In addition, the IRS and local taxation authorities use fair market value to determine the property's tax assessment or for a tax deduction after a casualty loss.

## How Does Fair Market Value Affect My Taxes?

Tax authorities want transactions to happen at fair market value. For instance, let's say a parent sells shares in their family business to their college student for \$1 so that the student may be an owner of the small business. If the shares' FMV is higher, tax authorities (e.g. the IRS) may recharacterize the transaction for tax purposes. The parent will then need to pay income taxes on the disposition of shares as though they had sold them at FMV to a third-party.

FMV is essential when donating property, too, such as artwork to charities. In this event, the donor typically receives a tax credit for the value of donation—so tax authorities must make sure that credit is for the true FMV.

Appropriately applying fair market value to tax returns prevents adverse implications later or potential claims of fraud.

### Fair Market Value (FMV) and Real Estate

Real estate agents typically prepare a comparative market analysis (CMA) when looking to sell a property. A CMA will give the seller an idea of what a buyer might pay for the property. During the CMA, the agent compares the subject property with comparably sold properties.

For example, if you have two identical properties next door to each other and one sells for \$100,000, then the second property should be able to sell for at least \$100,000.

But the sales comparison goes beyond looking at just one recent sale, taking into account multiple recent sales—generally at least three properties. For example, there are four identical houses in the same neighborhood. Three of the houses recently sold for \$100,000, \$130,000 and \$125,00. To calculate FMV you would add up the three sale prices and divide the number of properties. In this case, the FMW is \$118,333.

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