What is Fair Market Value (FMV)?

Fair market value is like selling something at an auction…

When you put something up for auction, multiple people compete to purchase it. Since buyers are bidding against each other, there is a better chance that you will sell the item for its true value (assuming everyone is freely making the deal and knows enough about the item being sold). If there’s only one possible seller and the buyer doesn’t have all the relevant information, the item is more likely to sell for a price other than its fair market value.

The fair market value (FMV) of an asset is what it would sell for in the open market, assuming buyers and sellers are reasonably knowledgeable, are acting in their own best interests, and aren’t under external pressure to complete the transaction.

External conditions, like a shortage or restrictions on transporting a product, could change the market price of a good — what it can actually fetch on the market right now — but don’t affect its fair market value.

It’s hard to put an accurate price on certain assets, especially those whose worth changes often or that aren’t bought and sold frequently. Consider the value of a house. Is it worth what the owner paid for it? The amount it would cost to build a new house if a hurricane knocked it down? Or how much it would sell for today? There are a lot of ways to assign a value, each of which produces a different answer.

Even if someone bought a house for $400,000 a decade ago, if you’d expect to pay closer to $600,000 to buy that home today (assuming an open market and knowledgeable parties), then its FMV is $600,000.

Knowing the fair market value (FMV) of an asset is useful in several situations. One example is property taxes. Local governments typically assess property taxes based on the FMV of a home. This allows the government to collect taxes more equitably. If it charged taxes based on the previous sale price, that would give an advantage to people who purchased their homes at a low price long ago or who increased the value of their houses by adding upgrades or making repairs.

The assessed value of a home can also be relevant when you’re shopping for home insurance, filing an insurance claim, refinancing your home, or trying to get a home equity loan.

FMV can also be useful if you’re deducting charitable contributions on your income taxes. If you donate a painting to a local charity, for example, you can use the FMV of the artwork to determine the size of the deduction to claim on your tax return.

The Internal Revenue Service also considers FMV when assessing gift and inheritance taxes. If you give an asset, such as a car, to a friend, the IRS uses its FMV when determining whether to charge gift taxes. The IRS also uses FMV when determining tax liability for some inherited assets.

FMV also comes into play in the insurance industry. Some policies cover the full replacement cost of insured goods, giving you enough to replace damaged items with similar, new products. Other policies only pay you the value of the goods at the time they were damaged. To come up with this amount, they rely on FMV.

Fair market value (FMV) and market value are similar terms that refer to slightly different concepts.

The market value of a product is the price for which it is most likely to sell at the moment. For example, the market value of a share of stock is the amount you could get if you sold it on a stock exchange.

FMV is a legal concept based on the market value of a product. For example, federal law describes the FMV of real estate as “the price at which... property would change hands between a willing buyer and seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.”

In most cases, fair market value and market value are the same. However, there are some scenarios in which they can differ, such as when one of the parties is less knowledgeable or when extenuating circumstances compel someone to make the transaction.

For example, someone who is being conned into making a purchase doesn’t have full information about the thing they’re buying. That means they could wind up paying a higher price than the fair market value.

People often ask professional appraisers to help them determine the value of expensive items, such as real estate. Appraisers examine the property and give their best estimate of its worth.

The fair market value of a piece of property is what a buyer and seller decide it is worth when they have all the relevant knowledge and no pressure to make a deal. In these conditions, if someone is willing to pay $250,000 for a home and the seller thinks that’s a reasonable price, the home’s fair market value is $250,000. Even if an appraiser examines the property and decides it should be worth $350,000, that appraised value does not directly affect its fair market value.

Put another way, the appraised value of something, whether it be an antique or piece of real estate, is one person’s opinion of its value. This may influence what others are willing to buy or sell it for, thereby indirectly affecting its fair market value. But buyers and sellers could choose to ignore an appraisal if they feel it is unreasonably high or low.

There are many ways to determine the FMV of goods, and the methods vary depending on the things you’re valuing.

You can work with professional appraisers, find the average value for the product from different sellers, or analyze the value of similar products.

You can use similar, recently sold items as the basis for assigning an FMV to your assets. For example, if a comparable home in your neighborhood sold for $250,000 last week, you can assume that your home has an FMV of roughly $250,000. If you’re buying a painting, you can look at the price of recently sold paintings of similar quality by the same artist.

Appraisers can also help you assign an FMV to an asset based on their expertise and knowledge of the market.

Finding the fair market value of a stock is typically straightforward. Stock exchanges track the most recent price for trades of each share on the exchange. You can find the FMV of a stock by averaging the highest and lowest sale prices each day.

The exception to this method is highly illiquid securities. If only a few hundred or even a few thousand shares trade hands each day, the most recent transaction price may lag behind the actual FMV of the stock.

Stocks for private companies don’t trade on an exchange, so you have to estimate FMV through other means. You can base it on the value of shares awarded in recent investment rounds, the estimated valuation of the company, financial performance and projections, and other factors.

Understanding fair market value is essential because it plays a role in many industries you may interact with, such as real estate and insurance, and can affect your taxes.

In real estate, FMV impacts whether you can borrow money to buy a home. Lenders rely on assessors to determine the FMV of a home and won’t lend you more than that amount to purchase it. If the amount you want to borrow is too high compared to the FMV, you may also have to pay additional fees, such as private mortgage insurance.

The FMV of your home or assets can also affect your insurance benefits and coverage. If your home burns down or burglars steal your jewelry, the insurance company may refer to the FMV of these assets when paying out.

The Internal Revenue Service considers FMV when calculating gift and inheritance taxes. If you give a painting or a car to someone, the IRS uses the FMV of that asset to decide whether to assess gift taxes.

When someone passes away, the IRS uses the FMV of their assets to determine estate taxes. Even if they only leave a small amount of cash, a decedent who leaves millions of dollars worth of real estate and antiques may have to pay estate taxes based on the value of those assets.