Fair Market Value

Fair market value (FMV) is the price at which property would change hands between a willing buyer and a willing seller, when neither is under any compulsion to buy or sell and both have reasonable knowledge of the relevant facts. The definition is long-established in US tax law, most famously in the Treasury regulations for estate and gift tax, and it is widely used in courts, insurance claims, divorce settlements, charitable donations and business sales.

Fair market value is a hypothetical price. It does not depend on what a particular person paid or would pay, nor on what the owner thinks the asset is worth. It assumes an open market, enough time to find buyers and a transaction at arm's length. It is closely related to, but not the same as, the "fair value" used in financial reporting standards, which is explained below.

In the United States, FMV appears throughout the tax system:

• Estate and gift taxes are assessed on the FMV of property at the date of death or the date of the gift.
• Deductions for donations of property to charity are generally limited to the FMV of the item, and the Internal Revenue Service requires a qualified appraisal for most non-cash gifts above $5,000.
• Heirs usually receive a "stepped-up" tax basis equal to FMV at the date of death, which affects any later capital gain.
• Non-cash compensation, such as company shares given to an employee, is taxed as income at its FMV when received.
• Local property taxes are typically based on an assessor's estimate of a home's market value.

FMV also matters for sales tax on barter transactions, for the value of assets traded between related parties and for buy-sell agreements among business owners.

For actively traded assets, such as listed shares, FMV is easy to find: it is generally the market price on the relevant date, or for estate purposes the average of the high and low trading prices that day. For most other property, valuers use one or more of three approaches:

• The market approach compares the asset with recent sales of similar items, as an estate agent does when using comparable home sales.
• The income approach estimates the present value of the cash the asset is expected to generate, often through a discounted cash flow model.
• The cost approach estimates what it would cost to replace the asset with one of equal usefulness, less wear and obsolescence.

For example, suppose a donor gives a painting to a museum. Three similar works by the same artist sold at auction in the past year for $38,000, $42,000 and $45,000. An appraiser adjusts for differences in size and condition and concludes that the FMV is $41,000. That figure, not the $6,000 the donor originally paid, sets the starting point for the charitable deduction, subject to the tax rules on the type of property and the donor's income.

Fair value, as defined by ASC 820 in US GAAP and IFRS 13, is "the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date." It is an exit price viewed from the market's perspective and is organized by a three-level fair value hierarchy. The two concepts usually produce similar numbers, but they are defined by different authorities for different purposes, and fair value applies to liabilities as well as assets.

Both differ from book value, which is historical cost less accumulated depreciation and is what usually appears on a company's balance sheet. A building bought for $2 million twenty years ago might have a book value of $800,000 and an FMV of $5 million. Broader valuation work often reconciles all three figures.

Because FMV is hypothetical, two qualified valuers can reach different answers, particularly for private companies, unique real estate or collectibles. Tax disputes often turn on these disagreements, and the IRS can impose penalties for substantial valuation misstatements.

• Internal Revenue Service