Fair market value (FMV) is the price of a certain property, business, or asset on the open market that is set when both parties comply with their deal’s conditions. A seller and a buyer should act in their own interests, be familiar with all the details about an asset, and not be pressured or influenced.
A successful deal requires both parties to enter the transaction of their own free will. For this purpose, a seller and a buyer should be aware of the relevant information about a product (property, business, or another type of asset), behave in their own interest, have enough time to complete their deal, and don’t succumb to the influence of interested people.
In this article, we’ll uncover the importance of fair market value, learn how to determine it, and review an example.
Why is fair market value important?
When certain conditions are met, parties can agree on a fair market value. It implies free and open market activity and can often be found in legal settings. It’s widely used by tax authorities and insurance companies. Tax authorities determine the amount of taxes based on this value and then collect them from the owners of certain assets.
Insurance companies utilize the value to insure their customers and to determine the refund amount in the event of an accident. When people make insurance claims, insurers know what sum of money to return if the insurance covers the case. For instance, if a person gets into a car accident, insurance compensates losses according to their vehicle’s FMV. In the real property setting, the value is widely used in divorce settlements to estimate compensation.
Now that you know about the importance of fair market value, let’s proceed to the next section to discuss how to assess it.
How to determine fair market value
You can utilize one of the fundamental ways to evaluate the FMV for your property, asset, or business:
- Use the selling price. This approach is the most acceptable for assets or property that have recently been purchased or sold. This means that they haven’t managed to lose their original price and characteristics yet. In this case, the selling price will amount to their fair market value.
- Take similar assets for comparison. When using this approach, consider comparables (assets that have similar characteristics to a subject property). If you want to sell a house, you can use the services of a real estate agent. This professional will provide you with a list of recent sales prices for similar houses in your area. As an alternative, you can also turn to other sources of information, for example, the internet, to find out the approximate price.
- Consider replacement cost. It refers to money one should spend to replace an asset, like property or business. The value depends on several factors (especially the market value of components of a property or business). Insurance companies often use the cost to define the value of an insured item. Therefore, you can consider replacement costs when setting an insurance claim or a tax return.
- Ask for an expert’s opinion. As an option, you can find a professional who will determine the value of your assets. Your expert’s resulting figure will be your fair market value.
To spot the value, transacting parties should follow several conditions. Firstly, an owner and a prospect should have all the necessary information about an asset that is up for sale. Secondly, it should be reliably known that both parties are acting in their own interests. Finally, a seller and a buyer ensure that the process is free from pressure.
The methods to determine the value are clear now, so let’s see our example.
Fair market value example
Let’s imagine that Oliver Brown, who lives in Phoenix, Arizona, wants to sell his house for $195,000. After checking on the relevant prices of similar houses in his area on the internet and consulting with an expert, Oliver decides to change the price to $225,000. Afterward, the seller contacts a real estate agent to find a buyer and informs them that the new owner will have to change the bathtub since there are some issues with the old one.
The agent finds Emily Williams, who is looking for a house in the area, and the option fits her perfectly. However, Emily has a budget of $210,000 for the house. After some negotiations about the problem with the bathroom, the owner agrees to sell the house for $210,000.
Hence, the FMV would be $210,000, and both the owner and the buyer are informed about all facts, do it in their own interest, and agree on the price.
All in all, FMV allows sellers and buyers to set fair costs for their assets and ensure that the transacting parties do everything for their own good voluntarily and without any pressure. During the selling process, a seller takes responsibility for reporting all the facts that may affect the price for a buyer, insurance company, or tax authorities.
- This article defines the term and uncovers the significance of fair market value.
- In this article, the author reveals the use of fair market value.
- This article provides readers with the advantages of fair market value.
Last Updated: 02.11.2021