What Is Fair Market Value?

Fair Market Value Explained

Real estate agent showing a house to a couple
•••

Mark Hunt / Getty Images

Fair market value is just that—the value at which one could reasonably expect to sell property on the open market. The Internal Revenue Service (IRS) uses the fair market value to determine the dollar value of charitable donations, assets that are converted to business use, and in various other tax-related matters.

Keep reading to learn more about how fair market values are determined, and how they compare to other valuations.

Definition and Examples of Fair Market Value

Fair market value is the price that a property would sell for on the open market. This means that both buyers and sellers who know the relevant facts about the property could be expected to agree upon the price without being pressured to accept the deal. If there are any restrictions on how the property may be used after the transaction, that must be reflected in the fair market value price.

  • Acronym: FMV

How Fair Market Value Works

FMV is an estimate of the market value of a property based on what an educated, willing, and unpressured buyer and seller could agree on, each behaving in their own best interest.

The concept of fair market value is used widely in business and life. FMV is used to determine how much you can write off for the donations of property you make to charities as goodwill. It determines if a gift tax is due to the federal government, as well as the value of an estate for estate tax purposes.

The concept of fair market value exists within a specific period of time for the transaction to occur. The FMV can change if the time period for the transaction changes.

Municipal property taxes are often based on FMV. It's used when you're filing an insurance claim, perhaps as the result of an automobile accident where the insurance company will cover damages up to the fair market value of your vehicle.

As an example, Fred is selling his home to Freida for $125,000. The house's basement floods with every hard rain, so nobody would be willing to pay much more than that price. The property has met the open market criteria.

Freida wants the property as badly as Fred wants to sell it, so neither the buyer nor the seller is being pressured by outside forces. Fred isn't desperate to sell, Freida isn't desperate to buy, and Freida is fully aware of the basement problem, so all the criteria for FMV are met. The property's fair market value is therefore $125,000.

Gift Taxes

Now let's say Fred gives the house to his daughter, Mary. He would owe a gift tax if he doesn't receive compensation from her that's equal to or more than the home's fair market value. If Mary gives Fred nothing in return, then the house is a gift and he owes a gift tax on the full fair market value of the home (after the first $15,000 that's exempt from gift tax).

However, let's say she pays him $50,000 for the property. The house is still a gift if its fair market value is $125,000. The difference between what Mary gave Fred and the FMV—$75,000—is subject to the gift tax.

The gift tax rate can be as high as 40% as of 2021, but the rate you pay depends on the total size of your gifts. In addition to the $15,000 annual gift tax exclusion, you can also dip into your lifetime exclusion amount to avoid gift taxes. As of 2021, you can give away $11.7 million throughout your life before triggering estate taxes.

Charitable Donations

The same basic concept applies to donated property a person gives to charitable organizations. What would someone be willing to pay you in today's economy for that used television in its current condition? That's its fair market value.

Luckily, most qualified charities publish lists online as to how much common donations are worth for tax purposes (assuming that your gift is in good condition). The IRS generally won't let you take a tax deduction for items that aren't in "good used condition," although exceptions exist for household goods worth more than $500 accompanied by an appraisal.

What Fair Market Value Is Not

There are some circumstances in which fair market transactions don't apply. They include eminent domain, where a property is taken in place of sale. The seller is under duress in this case, so the IRS criteria for fair market value haven't been met.

Examples of distressed sales in which fair market value doesn't apply include liquidation sales and deeds in lieu of foreclosure.

Fair Market Value vs. Intrinsic Value vs. Imposed Value

  Fair Market Value Intrinsic Value Imposed Value
Valuation Factors Based on precedent or extrapolation Calculated based on underlying factors, both tangible and intangible May be based upon precedent or analysis
Who Decides the Value Buyer and seller Analyst Court or other legal authority

Valuation Factors

An estimate of fair market value can be based on either precedent or extrapolation. As long as the buyer and seller agree upon the price with full knowledge of the property and without pressure, then it's fair market value. Place, time, comparable precedents, and the personal evaluation of each person involved in the transaction all play into the formation of FMV.

Intrinsic value might or might not be the same as the fair market value, but it depends on a deeper analysis of underlying factors and fundamentals. Intrinsic value is the actual value of a property or asset based on analytical techniques and underlying perceptions of its tangible and intangible factors. This calculation is common in the stock market; investors analyze securities in hopes of finding businesses that have a true, or "intrinsic," value that's lower than the fair market value it's currently trading at. This is also known as value investing.

Imposed values may be based on a mix of the other strategies—combining analysis with fair market considerations. Ultimately, it's up to the entity imposing the value to decide on the factors to include in the calculation of value.

Who Decides the Value

FMV is the subjective interpretation of the facts and information available at the time of assessment, and it's unique to the buyer and seller who determined that the price was "fair."

Intrinsic value is typically determined by an analyst who has expertise in analyzing property and calculating prices. These values can differ from one analyst to the next, depending on the factors they included in their calculations.

A legal authority, such as an existing tax regulation or a court, sets an absolute imposed value for the property.

Key Takeaways

  • A property's fair market value is the price at which a buyer and seller could reasonably be expected to agree upon.
  • Fair market value does not apply to situations in which either the buyer or seller is pressured to close the transaction (such as in cases of foreclosure), and both parties must have all the relevant information about the property (like being aware of any defects).
  • Fair market value is typically used to calculate the taxes owed on gifts or the deductions available for qualified donations.