Fair market value

Fair Market Value (FMV) is a term in both law and accounting that is based on the economics term of "market value." It is also a common basis for 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.

A fair market value is often an estimate of what a willing buyer would pay to a willing seller, both in a free market, for an asset or any piece of property. If such a transaction actually occurs, then the actual transaction price is usually the fair market value. Note that the opinion of people that are not interested in buying or selling an asset has little meaning, because they are not active in the market. Thus, "market value" (which is the same for everyone in the market) is not identical to the "intrinsic value" that different individuals may place on the same asset based on their own preferences and circumstances.

However, market transactions are often not observable for assets such as privately-held businesses and most personal and real property. Thus, FMV must be estimated. An estimate of Fair Market Value is usually subjective due to the circumstances of place, time, the existence of comparable precedents, and the evaluation principles of each involved person. Opinions on value are always based upon subjective interpretation of available information at the time of assessment. This is in contrast to an imposed value, in which a legal authority (law, tax regulation, court, etc.) sets an absolute value upon a product or a service.

An example of the relativity of Fair Market Value is when people buy or sell things above or under the price paid locally for similar items. This often happen in auctions, or when people simply don't take third party advice into consideration.

Contents 1 Definitions 1.1 Interpretation 1.2 Definition in the United States 1.3 Definition in Canada 2 References

Definitions

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

• 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. There is no longer any such value in real estate appraising as Fair Market Value, the correct term is Market value.

Interpretation

Fair Market Value is applicable upon services and goods that are offered in series/quantities. Simply, because FMV is based on comparison with identical or similar past, actual or expected service and goods. Briefly, Fair Market Value is an opinion. The acceptance of which determines price, which is a fact.

Fair Market Value is also a frequent standard of value used in appraising a business or professional practice. The FMV standard of value is presumed to be established by a sufficient number of arms-length transactions conducted in an appropriate secondary market. Careful comparison of the actual selling prices observed in such businesses sale transactions may provide a basis for the Fair Market Value estimation for the subject business.^[1]

Definition in the United States

In the realm of United States tax law, the definition of "fair market value" is found 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. United States v. Cartwright, 411 U. S. 546, 93 S. Ct. 1713, 1716-17, 36 L. Ed. 2d 528, 73-1 U.S. Tax Cas. (CCH) ¶ 12,926 (1973) (quoting from U.S. Treasury regulations relating to Federal estate taxes, at 26 C.F.R. sec. 20.2031-1(b)).

The term "fair market value" is used throughout the Internal Revenue Code among other federal statutory laws in the USA including Bankruptcy, many state laws, and several regulatory bodies.^[2]

Definition in Canada

Fair market value is not explicitly defined in the Income Tax Act. That said, Mr. Justice Cattanach in Henderson Estate, Bank of New Year v. M.N.R. , (1973) C.T.C. 636 at p. 644 articulates the concept as follows:

The statute does not define the expression "fair market value", but the expression has been defined in many different ways depending generally on the subject matter which the person seeking to define it had in mind. I do not think it necessary to attempt an exact definition of the expression as used in the statute other than to say that the words must be construed in accordance with the common understanding of them. That common understanding I take to mean the highest price an asset might reasonably be expected to bring if sold by the owner in the normal method applicable to the asset in question in the ordinary course of business in a market not exposed to any undue stresses and composed of willing buyers and sellers dealing at arm's length and under no compulsion to buy or sell. I would add that the foregoing understanding as I have expressed it in a general way includes what I conceive to be the essential element which is an open and unrestricted market in which the price is hammered out between willing and informed buyers and sellers on the anvil of supply and demand. These definitions are equally applicable to "fair market value" and "market value" and it is doubtful if the word "fair" adds anything to the words "market value."

In concert with this decision, the Canada Revenue Agency (CRA) lists the following working definition in its on-line dictionary:

Fair market value generally means the highest price, expressed in dollars, that a property would bring in an open and unrestricted market between a willing buyer and a willing seller who are both knowledgeable, informed, and prudent, and who are acting independently of each other. ^[3]

As the definition indicates, the Canadian and American concepts of fair market value are very similar. One obvious difference is that the Canadian working definition refers to "the highest price" whereas the American definition merely mentions "the price." It is debatable whether or not the presence of the word "highest" distinguishes the Canadian from the American definition.

References

1. ^ Use of the Fair Market Value standard in business appraisals.
2. ^ to wit, Internal Revenue Service Notice 2005-43
3. ^ Canada Revenue Agency Dictionary. Retrieved 11 November 2008 at http://www.cra-arc.gc.ca/tx/chrts/dnrs/dctnry/menu-eng.html#fmv

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