How to Calculate Fair Market Value
Fair market value is the reasonable selling price of a business, stock, real estate or other assets. Although this valuation is an agreed price between a buyer and a seller, other factors might be used to determine specific fair market value. Other factors are often prevalent when a property isn't being sold but instead being donated or inherited.
Fair Market Value Example for Inherited Assets
It is common for beneficiaries to inherit various assets that have appreciated over the lifetime of a decedent. Typical appreciated assets include stocks, mutual funds and real estate. The Internal Revenue Service defines the fair market value as the cost of the asset on the date it would have changed hands (the death date), establishing a new basis for the beneficiary.
For example, if a beneficiary inherits rental real estate property purchased originally for $50,000 but can sell it at the time of the inheritance for $500,000, the beneficiary would instantly have a $450,000 capital gain. The IRS instead requires beneficiaries to obtain a professional appraisal to determine the current fair market value that becomes the beneficiary's basis. If the inherited asset is a stock, the closing market price of the stock on the day of inheritance is used.
Alternative Valuation for Inherited Assets
The IRS does allow for an alternative valuation date that a beneficiary can choose using IRS Form 706. The alternative valuation date must be within six months of the date of death and is allowed for purposes of reducing total estate tax owed. This method does result in a higher potential income tax bill when the asset is sold.
For example, if an inherited stock had a value of $30,000 at the time of death but then the price dropped four months later to $25,000, this lowers the ultimate estate value by $5,000. Even though the estate value is lowered, selling the stock for $29,000 yields a $4,000 capital gain. Consider the entire estate value before using alternative valuations.
Donated Assets
Businesses might donate outdated office equipment to charities. These could include items such as computer equipment, copiers, tools or even automobiles or delivery vans. The IRS requires the charity to provide donor a letter with the total value of the donation. This value must be the fair market value. Charities might use public information or appraisals to define the fair market value. For example, a donated van could be valued based on an Edmunds car valuation estimate. Specialized equipment would look at comparable sales of similar equipment of similar age and use.
For example, a florist donates two delivery vans to a local church. The church goes to Edmunds and searches the value of each van based on the year, make and model as well as the miles driven and overall condition of each van.
Adjustments to Assets
Real estate value is not always determined based on a price that a buyer and a seller agree on. It isn't uncommon for buyers in very hot real estate markets to offer a price higher than other similar homes in the neighborhood. For example, a seller might aggressively list his home for $500,000 and a buyer agrees to that price. This should meet the qualifications to determine the fair market value – what a buyer is willing to pay for an asset.
However, if a loan is used to fund the transaction, there is another party that has a say in the value of the home. A lender doesn't want to lend more than what is required. An appraisal looks at comparable properties sold in recent months. If the appraisal says the home is worth only $450,000 in the current market, the lender will limit funding to that amount. Buyers then have a choice to either renegotiate the purchase, walk away or find funding for the difference that the bank won't lend.
Warning
Assets that don't have a common market or are unusual may need specialized evaluation to determine a fair market value.
References
Tips
- Keep an eye on economic or industry news that may increase or decrease the fair market value of an asset. This may include stock market trends for equities or mortgage rates for real estate.
- The value of stock on the date of death is the fair market value for estate tax purposes and becomes the beneficiary's new cost basis. Real estate is valued as soon as is feasible when dealing with inheritance.
Writer Bio
With more than 15 years of small business ownership including owning a State Farm agency in Southern California, Kimberlee understands the needs of business owners first hand. When not writing, Kimberlee enjoys chasing waterfalls with her son in Hawaii.