Fair Market Value in Real Estate for Tax Purposes

Real estate agent showing a house to a couple
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Fair Market Value (FMV) is an important concept in the valuation and exchange of real property and other property. The Internal Revenue Service uses it to determine the dollar value of charitable donations, assets converted to business use, and in various other tax-related matters.

The Definition of Fair Market Value

The overarching definition of fair market value comes from the Internal Revenue Service Publication 561.

Fair Market Value is the price that property would sell for on the open market. It is the price that would be agreed on between a willing buyer and a willing seller, with neither being required to act, and both having reasonable knowledge of the relevant facts. If you put a restriction on the use of property you donate, the FMV must reflect that restriction.

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

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. The fair market value of the property is then a fair valuation or assessment of its worth.

An Example—Gift Taxes

Let's say Joe gives his daughter Mary his house. He would owe a gift tax if he does not receive compensation from her that's equal to or more than the home's fair market value.

The question of fair market value becomes moot Mary gives Joe nothing in return—he owes a gift tax. But let's say she gives him $50,000 for the property. Is that a gift? Not if the house's fair market value is $50,000. If it's worth more, its value over this threshold is taxable.

So how does the IRS determine the home's fair market value according to the Publication 561 definition? First, what could Joe have sold the property for in the current market, assuming it's not a fire sale? He's not desperate to sell because of some circumstance. He's not required to act and dispose of the property.

Nor is the buyer desperate to purchase the home for any reason. He's not required to act, either. Both buyer and seller are aware that the basement leaks and the buyer's offer are based on this information: $100,000. Both have a reasonable knowledge of relevant facts.

The IRS says that $100,000 is the fair market value of the property under these circumstances. Joe has therefore made Mary a gift of $50,000 if he accepts just $50,000 for the property.

Charitable Donations

The same applies to the 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 is its fair market value.

Luckily, most qualified charities publish lists online as to how much-donated items of clothing and other personal property are worth for tax purposes, always assuming that your gift is in good condition. The IRS generally won't let you take a tax deduction for most items otherwise.

Fair Market Value vs. Intrinsic Value

An estimate of fair market value can be based on either precedent or extrapolation. FMV differs from the intrinsic value in that intrinsic value is the actual value of a property or asset based on analytical techniques and underlying perceptions of its tangible and intangible factors.

Intrinsic value might or might not be the same as the fair market value. For example, investors analyze securities in the hope of finding investments where the true or intrinsic value of the investment exceeds its current fair market value.

Fair Market Value vs. Imposed Value

Place, time, comparable precedents, and the personal evaluation of each person involved in the transaction all play into the formation of FMV. It's the subjective interpretation of the facts and information available at the time of assessment.

It is different from imposed value, in which a legal authority, such as a rule of law, existing tax regulation, or a court sets an absolute value for the property.

What Fair Market Value is Not

There are some circumstances where fair market transactions don't apply. They include eminent domain, where a property is taken in lieu of sale. In this case, the seller is under duress. They also include liquidation sales, deeds in lieu of foreclosure, and distressed sales.

Uses of Fair Market Value

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 such as Good Will. It determines if a gift tax is due to the federal government, and the value of an estate for estate tax purposes.

Municipal property taxes are often based on FMV as well. It's used when 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 the owner's vehicle.