Fair market value

From Wikipedia, the free encyclopedia

Fair Market Value is a term in both law and accounting to describe an appraisal based on an estimate of what a buyer would pay a seller for any piece of property. It is a common way of evaluating the value of property when assessing damages to be awarded for the loss of or damage to the property, generally in a claim under tort or a contract of insurance.

[edit] Definitions

A classic formulation of the definition of "fair market value" is found (in the specific context of U.S. tax law) in the United States Supreme Court decision in the Cartwright case:

The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.^[1]

There are numerous definitions of fair market value for various purposes and jurisdictions. A highly general definition follows.

• It is the most probable price at which a good or service will exchange, expressed in terms of cash or equivalent, in a free market assuming:
  • A knowledgeable and willing seller unencumbered by undue pressure to sell and acting in his own best interest
  • A knowledgeable and willing buyer unencumbered by undue pressure to buy and acting in his own best interest
  • A reasonable time for exposure in a free and open market

Under this concept, a real estate sale in lieu of an eminent domain taking would not be considered a fair market transaction since one of the parties (i.e., the seller) was under undue pressure to enter into the transaction. Other examples of sales that would not meet the test of fair market value include a liquidation sale, deed in lieu of foreclosure, distressed sale, and similar types of transactions.

[edit] Proving fair market value

Fair market value is generally proved by expert evidence, although for commonly traded goods (such as new retail goods or securities) a court can take judicial notice of the price. Often, the fair market value is based on a date prior to the hearing that would establish damages, such as the date the property was destroyed, or the date of a separation when assessing the value of matrimonial property that is sold at a later date.

For example, if a used car is destroyed in a crash, the insurance policy will generally only pay for the fair market value of the car at the time of the accident. This can generally be determined by looking at Kelley Blue Book values, or the costs of buying similar vehicles being sold by used car dealers in the local area.

Generally, the less liquid and more unique a piece of property is, the harder it is to accurately determine its fair market value. For example, farm land is generally treated as a commodity and its fair market value can be determined with relative ease by comparing the sale prices of neighbouring properties. However, the fair market value of a unique property, such as the Empire State Building, would be difficult to determine as even other New York skyscrapers are rarely if ever sold on the open market.

[edit] Practical applications of the fair market value concept

Property taxation systems such as Market Value Assessment are generally based on the fair market value of the property. Online tools can help anyone estimate the fair market value for property providing informtation such as nearby recently sold residential property, neighborhood, average prices, average price per square foot, property appreciation and display individual property locations on Zillow.

Alternative pricing schemes, particularly for commercial properties, are Replacement Value, or what it would cost to re-build the building that exists on the site, or Commercial Value, based on the assumed rental income and the rate of return on capital investment for similar properties. These values can often give wildly different estimates than a fair market value approach.

[edit] Notes