Fair Market Value

What Is Fair Market Value?

Fair market value is the price at which a willing and qualified buyer and seller exchange an asset. The phrase is used in the Internal Revenue Code and bankruptcy laws, several state laws, and several regulatory agencies.

The actual world is not the domain of fair market value (FMV). It's a unique universe in which individuals are expected (specified) to behave in predictable and specific ways. It's a universe of false eager buyers and sellers and fictitious transactions.

The real world is filled with individuals who engage in actual transactions with uncertain outcomes and whose activities are unpredictable and not susceptible to consistent description. 

It's no wonder that these two worlds, the hypothetical world of real market value and the actual reality, occasionally clash over the worth of firms and commercial interests.

Understanding Fair Market Value (FMV)

Given the following criteria, FMV is the price that two parties are prepared to spend for an asset or liability.

Both parties are aware of the current condition of the asset or liability. There is no excessive pressure on either side to buy or sell the item, and there is no deadline to meet.

If these requirements are met, the parties' final price should fairly reflect the asset or liability value at the time of the transaction.  

Such a transaction is not feasible; a cluster of data points from earlier real market transactions, projected for the asset or obligation under consideration, may be used to determine this value.

The most frequently accepted valuation standard is undoubtedly the market value. It's often used to determine the worth of a business or a business interest for sale or taxation, the IRS writes in Revenue Ruling 59-60.

"The price at which the property would change hands between a willing buyer and a willing seller, where the earlier is not obligated to buy, and the latter is not obligated to sell, and both parties have a reasonable awareness of important facts"

The expected price in an open and unfettered market estimates property value. This benchmark differs from "strategic" or "investment" value, which relates to a company's perceived worth to a specific investor. 

Value of the market may include discounts to reflect a company's lack of control or marketability, depending on the size of the business interest and restrictive agreements.  

Financial and accounting experts have some flexibility in determining the actual value of an asset, with market value serving as the starting point. This is what distinguishes fair market value. 

Analysts can change market value based on their forecasts for their specific market situations when relevant. 

In most cases, an analyst determines FMV by assuming that the market consists of highly educated buyers and sellers who have information regarding the approximate fair value of the asset. 

Keep in mind that the market price typically considers standard selling conditions rather than an imminent need to liquidate an item, which might negatively impact the seller's idea of a fair market value. 

Examples of fair market value (FMV)

If you're selling a used automobile, for example, the highest bid received from a buyer is the FMV if the previously mentioned two requirements are followed. Similarly, if you're selling a home, your goal is to find a buyer willing to pay the expected amount (or more).

If the house is overpriced, it will be on the market for longer, but the chances of finding the highest-paying buyer will improve (and vice versa). 

As a result, evaluating the home's fair market value ahead of time might assist in properly pricing the property such that the following factors are balanced:

• Goal Purchase Offer Received
• Time Needed Until Closure

Another example would be the share prices of publicly listed corporations, where the most recent trading price (i.e., the most recent transaction) indicates the stock's fair value (at that moment). The average trading price for the day can be used to arrive at a "normalized" share price. 

However, it must be noted that rarely will a stock's actual intrinsic value be equal to its last traded price in the market. Therefore, buyers and sellers will look to exchange the asset at the next best possible cost.

When it comes to settling legal problems, such as during a divorce settlement or when private property is damaged, when two heirs are awarded one piece of property, and one wants to buy out the other, fair market value becomes a highly significant (and often passionately contested) statistic.

Market value ensures that all parties are on the same page regarding the worth of all shared assets, preventing one side from taking advantage of the other. 

Each year, the value of a residence is used to compute a homeowner's property tax payment. The tax rate in each municipality is different. For example, if your home is valued at $300,000 and your county's property tax rate is 3%, you will owe $9,000 in annual property taxes.

Other taxes involving property and real estate, such as estate tax, gift tax, and inheritance tax, are influenced by FMV. 

If an heir inherits a residence or receives it as a gift, they must pay property taxes on the property's value, regardless of how they acquired it or if it was "given" to them for free.

How is Fair Market Value (FMV) used?

Depending on the accounting technique used by a company, FMV may or may not be used. Short-term assets, such as marketable securities, are often valued at their market value because there is no secondary market for these securities, and everyone who trades receives the same price. 

Business accounting standards will advise on when and if an asset can be recorded on the financial statements at fair market value and exchange-traded securities.

Until they are fully depreciated, most assets are recorded according to their book value. Then, asset owners can account for their investments using a forecasted FMV.

Assets are often assessed at their fair market value for measuring personal net worth. Another critical example is real estate holdings. Like the  American Society of Appraisers and the Internal Revenue Service, which can set standards for appraisers.

The term (FMV) is frequently used in the insurance sector. For example, when a car accident occurs, the insurance company covering the damage to the owner's vehicle would normally pay damages up to the vehicle's FMV.

FMV is determined by appraisers for various purposes, including taxation.

Donating property to charity, such as artwork, is another area of taxes where FMV is frequently used. The donor is commonly given a tax credit for the amount donated in these situations. 

Tax authorities must guarantee that the credit offered is for the real FMV of the item, and they frequently request that donors submit independent appraisals for their contributions. 

Correctly applying fair market value to taxes assures that there will be no negative financial consequences or charges of fraud from authorities in the future. 

How Do You Calculate Fair Market Value?

There are a few alternative approaches to appraising rather than calculating this value, first, by the amount the item costs the seller, as determined by a list of sales for similar assets, or by an expert's assessment. 

A diamond appraiser, for example, would most likely be able to recognize and calculate a diamond ring based on their previous experiences. 

"The price for which you might sell your property to an interested buyer when neither of you has to sell or purchase and both of you know all the essential facts," explains Fair Market Value. 

Comparing the prices others have paid for something similar or identical is possibly one of the t best ways to assess your property's fair market worth. 

How Do I Know the Fair Market Value of My Home?

Unlike other parts of purchasing and selling real estate, there is no set method for assessing a home's value. Moreover, because real estate is traded on the open market, the value of these financial assets is susceptible to market swings. 

Supply and demand are two significant factors that decide real estate prices. As a result, the buyer's and seller's particular circumstances and desires to acquire and sell will have a sizable influence on a home's fair market value.

Therefore "FMV" isn't always about the intrinsic value of a piece of real estate. The actual price might vary depending on what the buyer or seller thinks it's worth. With this in mind, here are the following ways a rough FMV can be calculated:

• Based on their reasonable understanding of the property and current market trends, a willing buyer and a willing seller agree on a property's worth.
• Comparative market study of other properties in the region that are similar.
• Having a professional appraiser assess the property's worth. While the assessed value is not the final word on FMV, it can typically serve if one is required. An appraisal also confirms the amount of money a lender will lend on the house, which is frequently an approximation of the open market value.
• Calculate a rough cost per square foot estimate. Divide the square footage of comparable residences in your neighborhood by the price. Then multiply that price amount by the number of square feet in your house.

Difference between fair value and market value

Fair value is a comprehensive measure of an asset's worth that differs from market value, which refers to the sale price of an object. 

Fair value is a term used in accounting to refer to the estimated worth of a company's assets and liabilities as reported on its financial statement. It's also used to calculate the price of a stock or other marketable securities.

The value of assets determined by the market is known as market value. The current market price or stock price is used to calculate market value.

The market value is determined by supply and demand and investor sentiments. Therefore, market pricing and fair value are not necessarily the same.

The fair value of calculated based on

• Market price
• Comparable prices of similar assets
• Discounted cash flow method

Because market value depends on various circumstances and varies at times, it is not an effective technique for estimating an asset's intrinsic worth. On the other hand, Fair value determines the asset's genuine inherent worth.

When determining the actual worth of an asset, the fair value is always modified for impairment. Markets, on the other hand, are decided by parties' afterthoughts and discussions, and they arrive at a final price that is not logically motivated.

In most circumstances, fair value is used to determine the fundamental worth of an item. The true value of an asset is its real value. The market and its forces constantly assess market value. Therefore, fundamental value is not necessarily comparable to market worth.

A considerable role is played in estimating fair industrial value and market value. Companies assess their assets using a variety of methodologies and determine the value that is convenient and profitable for several parties involved.

Determining fair value is difficult and expensive in any free-market environment. 

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Book Value

• Book Value vs Fair Value

• Market Value vs Book Value

• Net Book Value (NBV)

• Types of Assets