Steps to Find Fair Market Value in Real Estate for Taxes
“Fair market value. Assessed value. Appraised value. What is the real value of a home today? ”
A willing buyer not required to act
A willing seller not required to act
Buyer and seller both have “reasonable knowledge of the relevant facts”
Reflecting any restrictions placed on the use of the property
Those qualifications rule out any type of real estate sale that occurs out of distress, including short sales and foreclosure auctions. That’s why buyers can often get the lowest prices when taking advantage of those sales. The buyer is required to act in order to make the most of a bad situation or the home was seized due to nonpayment and the bank needs to sell the property quickly.
Summing it up,
The IRS considers fair market value the price that a willing buyer and seller would agree on without any requirement to strike a deal, assuming both parties are fully aware of all relevant facts pertaining to the property. If the property is designated for use in agriculture or another specific restriction, then the FMV must also consider the value of the property for that intended use.
It’s important to note that the FMV of a property doesn’t take into account a close inspection of the property. The valuation focuses more on what a reasonable buyer might willingly pay for the property and what a reasonable seller might accept in exchange. There is a way to determine value based on the condition and features of a property, and we’ll discuss that below.
Is Fair Market Value the Same as Assessed Value?
How does FMV differ from assessed value? The assessed value is the amount a county or city uses to determine what the property owner pays in taxes each year.
Location and Tax Bracket
While the fair market value is sometimes considered when assigning this value, it’s often influenced more by the location of the property and what tax bracket it falls into.
It’s Important Only For Taxes
The assessed value is often significantly lower than the FMV. Local governments often require homeowners to pay taxes on only a percentage of the home’s full value, and the assessed value represents that percentage. When selling or buying a home, it’s important to remember that the assessed value is only important to taxes. It doesn’t have much impact on what a home is listed for or how much a buyer is willing to pay.
Fair Market Value vs. Appraised Value
You may see FMV and appraised value used interchangeably at times, but there is a difference between these terms. Appraised valuation refers to the specific value placed on a property by a professional appraiser. It doesn’t take into consideration the value or selling price of other properties in the surrounding area or zip code. The only thing that matters is the actual property.
In some cases, mass appraisals are used. That means the shared features of properties in a given area are used to come up with one appraised value for all properties contained in that area. When an appraised value is used for tax purposes only, mass or individual appraisals may apply. That’s why the appraised value of a property is often different than the fair market value or assessed value.
The appraised value of a property is used to determine the assessed value for tax purposes.
Fair market value may or may not take the appraised value into consideration. The value does vary with the features and condition of the property but it’s more like a perceived value in the eyes of the buyer and seller.
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FMV In Real Estate Negotiations
Understanding how FMV works can help you save money when buying property or earn more money when selling. Most buyers don’t agree to the full asking price and sign on the dotted line without some type of negotiation. Some sellers price high with the expectation of negotiating a fair price while others list their property at the lowest price they’re willing to accept and refuse to negotiate.
Remember: FMV Is A Perceived Value by Seller and Buyer
Having the property appraised and inspected by a professional and analyzing other properties in the area will give you tools to negotiate a reasonable fair market value during the negotiation period. Remember, the FMV reflects the perceived value of the buyer and seller, so you’re trying to find a meeting point that satisfies both parties. Pointing out property damage or other issues revealed during an inspection may lower the value for the buyer while a high appraisal may give more power to the seller.
When a seller refuses to negotiate the price of a property, they must find a buyer willing to agree to that price as the FMV. Oftentimes, a real estate agent will know if a seller is willing to negotiate, but they’re also negotiating to earn the highest commission possible.
Determining a fair selling price can get complicated when negotiations and bidding wars are in play, but determining FMV for tax purposes isn’t always as difficult.
How Is Fair Market Value Determined for Taxes?
There is no set way to determine fair market value. You can’t plug numbers into a formula and come out with FMV in minutes. We’ve discussed how fair market value is often negotiated in real estate, and the same negotiations can happen when you buy other goods of value. From gemstones to used bicycles and produce in an open market, you can negotiate the FMV of many items if the price isn’t set.
When it comes to taxes, you may have some legal guidelines that you must follow to determine fair market value. There are laws for determining tax credits for charitable donations and property taxes assessed for houses and other select goods. It’s important to work with an accountant or other knowledgeable professional when purchasing, selling or donating valuable goods for the first time. They can make sure you’re aware of all guidelines, including loopholes that could save you some money.
To get a general idea of factors that may determine fair market value for tax purposes, let’s go back to Publication 561 from the IRS. That tax code discusses the FMV of donated property, but it introduces some of the most common factors used to determine fair market value in a variety of circumstances.
Cost or Selling Price
When donating an item, the price that you paid for the item originally should factor into the FMV. Alternatively, you might consider the price that a charitable organization received from selling the item after your donation. If there’s a way to put a set price on the item, that is typically included in the FMV evaluation.
Appreciation or Depreciation
It’s difficult to claim that an item is worth more than the price you paid for it or the price someone else was willing to pay for it. If you purchased at a low price and somehow altered the product to improve its usefulness or condition, then it may appreciate.
In most cases, an item is purchased and then receives a lower price valuation because it has lost value with age. The car that you drive for 10 years and then donate to charity has a lower FMV than it had when you drove it off the lot brand new. The same goes for the used clothing that you donate after your kids wear them for a year and other used items that you might sell or donate.
Sales of Comparable Items
Market research is an integral part of the real estate market, but it applies to other industries as well. That research requires an in-depth look at signs of value on items that are comparable to the one you’re buying, selling, or donating. It’s important to compare the value of items around the same time of your sale or purchase and in similar condition.
For instance, real estate market research may include homes within a certain neighborhood or zip code with the same approximate size and number of bedrooms and bathrooms. You can also research the sales price of gemstones, brand name clothing, and many other items.
Replacement Cost
If you were to replace the item, what would it cost you? It’s important to consider the age and overall condition of the item as well as any unique features it may have over similar products on the market. You always want to compare like items and then factor in the current economic times that may reduce or increase the value.
Expert Opinions
In real estate, you may consider the value assigned by an assessor or inspector. You may also have rare stamps, coins, gemstones, artwork, antiques, and many other items appraised by one or more experts. This is often a good way to price an item fairly if you don’t have a purchase or sales price to consider.
Putting It All Together
If you’re assessing the fair market value of an item for tax purposes, you need to present written proof of the value to the IRS or other taxing authority. There are often guidelines in the tax code that will determine the type of valuation paperwork deemed acceptable. You may also have special forms that you need to file in order to receive credit on your taxes or other incentives.
If you’re determining FMV for bargaining purposes with another person or entity, you may gather as much proof of favorable valuation as you can find. It often comes down to negotiation. In the absence of legal guidelines, the value will become whatever all parties can agree upon. The more proof of the value you have and the stronger your negotiation skills, the more likely you are to walk away with a price that is at least fair if not ideal for your goals.an>
Why Is Fair Market Value Important?
You don’t have to work as a professional tax manager or real estate agent to worry about fair market value. Unless you rent your home from others your entire life, you will encounter issues related to real estate tax and FMV.
Are you ready for some fair market value examples? Consider some of the most common scenarios that bring property owners and buyers into the realm of FMV and property taxes:
Property Taxes
You put your home on the market or decide to buy a home. Understanding fair market value and how it differs from assessed and appraised market values will make the process easier. If you list your home for sale without the help of an agent, it’s critical that you understand the FMV of your property.
Gift Taxes
You can’t just give real estate property to someone else for free. You will either pay the IRS a gift tax or sell the property for fair market value. That explains why you don’t often hear about someone giving away a house for a dollar or even $100. Very few homes are fairly valued at such a low price, and most owners don’t want to pay a gift tax.
Estate Taxes
FMV is important when handling the estate of a property owner. Whether an estate tax is owed and how much is paid is determined by the history of ownership, the fair market value of the property, and other factors.
Charitable Donations
When gifting property to a charity, you can claim the property’s FMV on your taxes. The rules for charitable donations of substantial value are complex, so you should work with an experienced accountant or tax professional when donating a home or other property for the tax benefits.
Insurance Claims
Insurance companies often use FMV to determine how much they will pay for repairs or replacement when you file a claim. That relates not only to the homeowner’s insurance but also auto insurance, renter’s insurance, and other types of insurance policies.
To Sum Up,
At this point, fair market value should seem less confusing. Take this information into your daily life to ensure you make smart decisions when handling all types of property. Before you buy, sell, gift, or donate anything, think about the FMV and the possible tax implications.
If the market value is central to your professional industry, make sure you stay on top of all applicable laws or standards of practice. Learning a variety of negotiation styles can also help you get the most for your money in professional and personal situations.