What FMV Is, What It’s Not, & Everything In Between
The first step in understanding your company’s fair market value (FMV) is to be aware of the FMV definition provided by the Internal Revenue Service which states:
“Fair market value (FMV) is the price that property would sell for on the open market. It is the price that would be agreed on between a willing buyer and a willing seller, with neither being required to act, and both having reasonable knowledge of the relevant facts. If you put a restriction on the use of property you donate, the FMV must reflect that restriction.”
In other words, FMV stems from a willing buyer and a willing seller, both of whom have ample time and information to make a decision suitable to their respective interests. It is commonly used in the real estate market, insurance claims, investments, and taxes. Before getting into these various uses, let’s take a quick look at what FMV is not and how it is determined.
What Fair Market Value Is Not
FMV should not be confused with market value, appraised value, intrinsic value, imposed value, or synergistic value. Market value refers to an asset’s price in the marketplace, such as a home’s listing price. An appraised value is the opinion of an appraiser and is not necessarily FMV, but may help determine FMV. Appraisals are often used in lieu of a true FMV. An intrinsic value arrives from an objective calculation of worth through fundamental and technical analysis. An asset’s intrinsic value may or may not be equal to its FMV. An imposed value is set by a legal authority, such as a court ruling or tax regulation. A synergistic value is a specific value to a particular investor based on their requirements and expectations, such as a rate of return. This value is typically greater than FMV.
When determining an asset’s FMV, according to Publication 561, any factor that could affect its value is relevant and must be considered. Such factors are the cost or selling price of the asset, sales of comparable assets, replacement cost, and opinions of experts. The IRS provides a table, recreated below referencing “Factors That Affect FMV,” from Publication 561, that illustrates various questions all business owners should ask with regard to these factors. These questions will help determine FMV as accurately as possible. These factors, however, are not all-inclusive and should not be treated as such.
What Factors Will Impact Your Company’s Fair Market Value?
|IF the factor you are considering is …||THEN you should ask these questions …|
|Cost or selling price||– Was the purchase or sale of the property reasonably close to the date of contribution?
– Was any increase or decrease in value, as compared to your cost, at a reasonable rate?
– Do the terms of purchase or sale limit what can be done with the property?
– Was there an arm’s-length offer to buy the property close to the valuation date?
|Sales of comparable properties||– How similar is the property sold to the property donated?
– How close is the date of sale to the valuation date?
– Was the sale at arm’s-length?
– What was the condition of the market at the time of sale?
|Replacement cost||– What would it cost to replace the donated property?
– Is there a reasonable relationship between replacement cost and FMV?
– Is the supply of the donated property more or less than the demand for it?
|Opinions of experts||– Is the expert knowledgeable and competent?
– Is the opinion thorough and supported by facts and experience?
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The Problem With Fair Market Value
There are also various problems to be aware of when determining FMV, such as unusual market conditions and the selection of comparable sales. If a comparable asset was sold in an artificial or stimulated market, its value will not be indicative of FMV. The weight given to a comparable property, moreover, depends on the degree of similarity between the two. All aspects should be considered when determining an appropriate weight. Additionally, reliance on past transactions may not accurately reflect probable future earnings and FMV.
How To Use Fair Market Value
Now that we have a better understanding of what FMV is and how it is determined, we can discuss its various uses.
The FMV of a property has multiple implications. When attempting to sell a property, the FMV will determine if you should receive more or less than the market price. It may also illuminate what improvements could be made to achieve FMV. Additionally, property tax is often based on the FMV of the property and has likely increased since its last appraisal. FMV could also impact your gift tax, estate tax, tax credit, and tax deductions after a casualty loss. If your property is included in an inheritance, for example, the heir will have to pay taxes on the FMV of the property. On the other hand, if the property is sold, a capital gains tax may have to be paid on the difference between the sale price and the FMV.
When property is damaged, insurance claims are used to cover the cost of the loss. If your property is valued below FMV and it is damaged, you will not receive appropriate compensation from your insurance company.
The FMV of investment assets, such as stocks and bonds, is vital information to know before investing. The market price of a security may be inflated (or deflated) compared to the FMV and will indicate if you are paying at a premium (or discount) for the security.
Though there is no exact formula to calculate FMV, it is important to be aware of the various factors that may be influencing the value. Additionally, FMV may resemble or closely match other values seen frequently throughout transactions; due diligence must be exercised to distinguish these values and conclude if a deal is in your best interest.
How does Rea & Associates fit into the picture? Our valuation & transaction advisory services team offers a range of solutions. Specifically, our transaction, tax and IRS-related valuations would assist you with anything involving FMV. Whether you are buying or selling a business, estate planning or gifting, we can establish an appropriate value to make life that much easier.
If you, or someone you know, requires a business valuation for estate, gift, litigation, merger and acquisition, or business planning purposes, please contact Rea & Associates to learn more about our services.
By Duncan Copeland, Valuation and Transaction Advisory services (Dublin office)