Fair Market Value (FMV): Definition and How to Calculate It

What Is Fair Market Value?

Fair market value (FMV) is the price a product would sell for on the open market assuming that both buyer and seller are reasonably knowledgeable about the asset, are behaving in their own best interests, are free of undue pressure, and are given a reasonable time period for completing the transaction.

Given these conditions, an asset's fair market value should represent an accurate valuation or assessment of its worth.

This definition of the term is commonly accepted in tax law, bankruptcy law, and the real estate market.

Understanding Fair Market Value (FMV)

The term fair market value is intentionally distinct from similar terms such as market value or appraised value because it considers the economic principles of free and open market activity. In contrast, the term market value refers to the price of an asset in the marketplace. Therefore, while a home's market value can easily be found on a listing, the fair market value is more difficult to determine.

Similarly, the term appraised value refers to an asset's value in the opinion of a single appraiser, thus not immediately qualifying the appraisal as fair market value. In cases where a fair market value is needed, an appraisal will usually suffice. 

Due to the thorough considerations made by the term fair market value, it's often used in legal settings. For example, fair market value in real estate is commonly used in divorce settlements and to calculate compensation related to the government's use of eminent domain.

Fair market values are also often utilized in taxation, such as when determining the fair market value of a property for a tax deduction after a casualty loss.

Practical Uses of Fair Market Value (FMV)

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 is also often used in the insurance industry. For example, when an insurance claim is made due to a car accident, the insurance company covering the damage to the owner's vehicle usually covers damages up to the vehicle's FMV.

Fair Market Value (FMV) and Taxation

Worldwide tax authorities always ensure that transactions 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, suppose the FMV of the shares is higher. In that case, tax authorities such as the Internal Revenue Service (IRS) may well recharacterize the transaction for tax purposes. 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.

Another field of taxation where FMV regularly comes into play is donating property, such as artwork, to charities. In these cases, the donor usually receives a tax credit for the value of the donation. Tax authorities need to ensure that the credit given is for the actual FMV of the object and often ask donors to provide independent valuations for their donations. Correctly applying fair market value to taxes ensures there won't be adverse monetary implications later on or any claims of fraud by authorities.