What is fair market value, and how is it calculated?

Fair market value or FMV is the reasonable selling price of a business, property, or asset in an open and competitive market where the buyer has adequate data, has sufficient time to complete the deal, is under no external pressure, and mutually agrees with the seller on the price. It is frequently used in real estate, investment, legal, stock market, etc. but can easily be applied to the buyer/seller market. You must be aware of the fair value of your asset to maintain clean books, raise capital, and more. Below, we will learn more about it, its importance, and how to calculate it. 

What is fair market value? 

Fair market value or FMV is typically the price of an asset when put up for selling in an open and competitive market. The fair market value depicts an accurate of asset valuation being exchanged when certain conditions are met. The conditions are: 

1. Both parties are behaving in their own self-interest. 

2. Sufficient time is provided to both parties to carry out the exchange. 

3. There shouldn’t be any mismatch in the information provided to the buyer and the seller. Both parties should be equally knowledgeable about the exchanged asset. 

4. There shouldn’t be any pressure on either party to carry out the transaction. 

How to determine it? 

All things that can be sold, bought, or bartered have a value. If you sell a house, the amount a buyer is willing to pay for it will determine its fair market value. According to the Income-tax Act, 1961, FMV shall be the higher of cost of acquisition of the property or the price that the property shall ordinarily sell for if sold in the open market. 

There is no fixed formula to calculate the FMV of a property. The technique most widely used to estimate FMV is to look at the sale instances of similar properties in the same neighbourhood. To calculate this value, you can use different methods to arrive at an asset’s approximate fair market value. We will take you through the two most common methods of determining fair market value: 

1. Ready Reckoner 

In order to avoid under-reporting of the consideration in sale agreements (which is done to avoid payment of appropriate stamp duty), states have introduced the system of predefined prices, depending on the area and nature of construction. This is done through stamp duty ready reckoner, or announcement of circle rates, etc., which are generally notified every year. So, you can find out the fair market value from the stamp duty ready reckoner of 2001, if the property was acquired prior to April 1, 2019. 

2. Obtaining a Valuation Report: 

In the appraisal method, an expert is hired to look at the asset and determine its first market value. If the ready reckoner rate is not available for a particular year, you have another option. You can obtain a valuation report, from a valuer who is registered under the wealth tax rules and who is recognised for determining the market value for income tax purposes. The registered valuer follows a standard process for the purpose of arriving at the valuation and issues a detailed valuation report for the same. This is perhaps the most effective way of determining the FMV of your asset. 

Factors affecting fair market value 

There is no fixed equation to calculate fair market value. As discussed earlier, value determination is based on the value of a similar product, a professional appraisal, or determining average market value. There are several factors that may affect the market value of your property. Below, we will discuss three such factors which can become the basis for adjusting your fair market value. 

• Previous purchase price of your property 

If the asset under evaluation has been purchased recently, the purchase price of the project can help determine its current fair market value. 

• The past sales price of a similar property 

When a property similar to the property under consideration was sold recently, the price at which the property was sold can help evaluate the fair value. 

• Replacement price of the asset 

The cost to replace the asset or the item may be relevant in determining its fair market value. 

Challenges of assessing the fair market value 

The biggest challenge in assessing market value is the lack of a fixed formula that can work in all situations. There is no one size fits all solution here. Due to its dependency on several factors, the fair market value of an asset is only as good as the appraiser’s expertise and the amount of information available to the appraiser. For instance, determining the market value of art and handmade items is difficult because they are mostly unique and there will be few or no comparisons available. Ultimately, fair market value is more of an estimation than a fixed valuation of any asset. 

Bottom line 

To put it in simpler terms, FMV is the price of a property that a buyer is willing to pay and a seller is willing to take under no external pressure and with access to complete information. The fair market value provides a lot of benefit to the seller as it helps in determining a price range that the buyer will be willing to pay and avoiding underselling themselves. While the concept of fair market value is simple, depending on the situation and the use of varied tools and services, the results may vary widely.