Real estate transactions can be tricky. Buyers nearly always want a deal, and sellers expect to sell their property for more than it’s worth. In a free market, the market sets prices by voting with their wallets. Fair market value is defined as the price at which an able, willing, and ready buyer will be produced.
What Is Fair Market Value?
The fair market value of a property is not necessarily what a given buyer or seller considers to be a fair price. It may be more or less than the price the seller would like to get. Conversely, it may also be more of less than a buyer is willing to pay.
This is basically an estimate of what a particular property would realistically sell for given current real estate market conditions. After being released into the market, the price will be modified, depending on interest.
Is Your Property Valued Fairly?
Determining fair market value calls for data such as recent sale prices of similar properties and time of year. It also describes a hypothetical transaction when property changes hands under certain conditions.
This value is based on a transaction described by answering “yes” to these questions:
- Is the price that would be paid in an arms-length transaction?
- Do both buyer and seller agree on price?
- Is neither being coerced?
- Do both parties have reasonable knowledge about the property, the market, and other relevant facts?
- Does the value take into account any restrictions on use of the property?
- Does the value include the element of time?
Any of these can affect the value of the property. For example, the price a willing buyer pays a willing seller today may not be as fair next year. After all, markets move regularly. Additionally, land restricted to agricultural use may be worth less than land without use restrictions.
Uses for Fair Market Valuation
Anyone in real estate needs to understand the definition of fair market value and how it’s calculated, as it comes into play in a number of real estate situations. Some of them are:
- Home sales: To avoid under-pricing or over-paying, you have to know the value of a property
- Tax purposes: Many taxing districts use the fair market value to assess property taxes
- Insurance claims: If property you own is damaged or destroyed, your insurance company may pay your claim based on the property’s fair market value
- Divorce cases: When a divorcing couple splits up financial assets, this concept may decide who gets what
- Lawsuits: In a lawsuit over a real estate deal, damages may be based on the property’s fair market value
- Estate taxes: Taxes on a deceased person’s estate are figured according to fair market value of property in the estate
- Eminent domain: If the government condemns property for public use, the owners may get compensated based on fair market value
- Gifts: If you give or get a gift of property, the gift tax is based on its value
- Donations. When you donate property to charity, the amount of your tax deduction depends on the property’s fair market value
A property’s fair market value may be different from its intrinsic or true value. A real estate investor, for instance, may be looking to buy properties with intrinsic value greater than the current value.
Intrinsic value may be greater than fair market value if the property could be rezoned to make it more valuable. Intrinsic value might also be greater if it is based on long-term potential instead of current value.
Tip: There are times when fair market value isn’t as relevant. For instance, foreclosed properties being auctioned may sell for prices very different than their FMV. Also, a motivated property owner is having a distress sale, so FMV may not be relevant.
How To Calculate Fair Market Value
There are several ways that you can estimate fair market value. Any one of them is likely to come up with a different number. Here are you may consider for different uses.
- Comparative market analysis: This is what a real estate agent does when suggesting a selling price for a listed property. It considers recent selling prices for properties of similar age, size, location, condition, and amenities.
- Appraisal: An appraisal is done by a professional appraiser. It looks at some of the same information as a comparative market analysis. It may, however, produce a different figure. Mortgage lenders often require appraisals before lending to real estate buyers.
- Replacement cost: Insurance companies often use replacement cost instead of fair market value when paying claims. This method considers the generally higher costs of land, materials, and labor to replace a building that was destroyed.
- Sale price: If a property recently sold in an arms-length transaction, the price gives a good idea of fair market value. The sale should be recent and the property in the same condition for this to be accurate.
- Online valuations: Real estate sites such as Zillow and Redfin use computer algorithms to automatically estimate property values. Online values aren’t as accurate or useful as ones you get with other methods. But they are convenient and can serve as a starting point.
Other Uses For Market Value
Fair market value may also be applied to non-real property. For instance, say you are donating office furniture to a charitable donation. The FMV of the furniture will determine how much you can deduct.
Charitable organizations may be able to provide you with fair market values for donated items. If you use TurboTax, the software can suggest values for donated items.
Tip: Check out Internal Revenue Service Publication 561 if you have questions about the value of donated items. It has details and examples for many different situations, including those involving real property.
Should You Know About Fair Market Value?
Fair market value is also basic information to know before making an offer on a property or offering one for sale. It’s also important for figuring taxes and making an insurance claim. Different methods for figuring fair market valuations may be used in different situations. Knowing how this figure is generated and what it means can help you make better real estate decisions.