Definition
Fair market value is an estimate of the market value of a property, based on what a knowledgeable, willing, and unpressured buyer would probably pay to a knowledgeable, willing, and unpressured seller in the market. An estimate of fair market value may be founded either on precedent or extrapolation. Fair market value differs from the intrinsic value that an individual may place on the same asset based on their own preferences and circumstances.
What is ‘Fair Market Value’
Fair market value (FMV) is, in its simplest expression, the price that a person reasonable interested in buying a given asset would pay to a person reasonably interested in selling it for the purchase of the asset or asset would fetch in the marketplace. To establish FMV, it must be assumed that prospective buyers and sellers are reasonably knowledgeable about the asset, that they are behaving in their own best interests, that they are free of undue pressure to trade and that a reasonable time period is given for completing the transaction.
Explaining ‘Fair Market Value’
Given these conditions, an asset’s fair market value should represent an accurate valuation or assessment of its worth.
Practical Uses of FMV
The concept of FMV is widely used across many areas of commerce. For example, municipal property taxes are often assessed based on the FMV of the owner’s property. Depending on how long the owner has owned the home, the difference between the purchase price and the residence’s FMV can be substantial. Professional appraisers use standards, guidelines, and national and local regulations to determine a home’s FMV.
FMV and Taxation
Worldwide tax authorities are always ensuring that transactions, especially those made between people not dealing at arm’s length, are realized at FMV, at least for tax purposes. For example, a father who is retiring may sell the shares of his business to his daughter for $1 so that she can carry on as the owner of the family business. However, if the FMV of the shares is higher, tax authorities such as the Internal Revenue Service (IRS) may well recharacterize the transaction for tax purposes, and the father will need to pay taxes on the disposition of the shares as though he had sold them at FMV to a third party.
Further Reading
- Fair value accounting, financial economics and the transformation of reliability – www.tandfonline.com [PDF]
- Economic reasons for reporting property, plant, and equipment at fair market value by foreign cross-listed firms in the United States – journals.sagepub.com [PDF]
- Financial reporting quality: is fair value a plus or a minus? – www.tandfonline.com [PDF]
- Did fair-value accounting contribute to the financial crisis? – www.aeaweb.org [PDF]
- Fundamental issues related to using fair value accounting for financial reporting – search.proquest.com [PDF]
- Assessing the impact of fair value upon financial crises – academic.oup.com [PDF]
- Fair value accounting is the wrong scapegoat for this crisis – www.tandfonline.com [PDF]
- Minority Discounts, Fair Market Value, and the Culture of Estate Taxation – heinonline.org [PDF]
- The decision usefulness of fair value accounting–a theoretical perspective – www.tandfonline.com [PDF]
- Fair value accounting for financial instruments: some implications for bank regulation – papers.ssrn.com [PDF]
