Fair Market Value (FMV) is a parameter used to establish the value of any asset – moveable or immoveable – such as automobiles, real estate, machinery & equipment, personal assets, etc. Determining FMV is important in transactions where the rights of ownership are passed from one party to another, through buying/selling, donating or gifting and so on.
According to the Internal Revenue Service (IRS), valuation is required for the following kinds of goods and property:
- Household goods, used clothing, gems and jewelry;
- Collections of rare objects, antiques, art, sculptures, etc;
- Real estate
- All kinds of automobiles, boats, aircrafts, etc;
- Business inventory, stocks and bonds, share/interest in a business/company;
- Financial instruments such as annuities, selected types of life insurance, etc;
Definition of FMV
In very simple terms, FMV is the price at which both seller and buyer agree to complete the transaction. It is not the same as ‘market price’, though some people tend to wrongly use these two terms as synonyms.
Methods to determine FMV
There are several methods used in determining fair market value, of which the following three are used most often.
- Market data comparison/sales comparison method: Also termed as ‘comparative market analysis’, this method involves comparing the value of properties which are similar to the property being valued and have been sold recently. For example, an independent home of 1200 sq. feet sells for a price of $5,000. Under the market data comparison method, a similar property will also be assigned the same fair market value, i.e. $5,000. The criteria applied when using this method are: (a) the property used for comparison must be in the same area as the property being valued; (b) it must have been sold within the last one year; and (c) the size, condition of property, age and time the property has been on the market, must be as similar as possible, if not alike.
- Cost of replacement method: This method calculates the costs necessary to reproduce or replace the property being appraised, i.e. if a similar structure has to be built on the same property, the cost of such construction is calculated in terms of time, materials and labor and added to the present land value, after deducting the estimated depreciation which has been accrued over the time since the original property was constructed.
- Income-analysis method: This method of determining fair market value calculates the income likely to be generated by two similar properties, by way of rent or capitalization. The method is used for large properties, such as commercial buildings or large multi-unit residential properties, where rent or price per unit can determine the total income which can be earned from the whole property.
Other methods for determining FMV are combinations of any of the three basic methods discussed here and the latest trend is to use technology in mapping and assessing property value.