Fair Market Value (FMV)

Fair market value (FMV) 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", in the words of the estate tax regulation, 26 CFR 20.2031-1(b). The charitable deduction regulation and the gift tax regulation use the same formula, and the IRS applies it across the tax code wherever property rather than cash changes hands.

Fair market value is a hypothetical price, not a recorded one. An actual sale between unrelated parties is usually the best evidence of it, which is why the related idea of an arm's-length transaction travels with it: a price set between family members or related businesses may be accepted, adjusted or ignored depending on whether it matches what strangers would have agreed.

What the standard rules out. The regulations add three refinements to the willing-buyer formula. Value "is not to be determined by a forced sale price", so a fire-sale or auction under duress does not set it. It is not the price in a market other than the one where the item is most commonly sold to the public, so a car's value is what a member of the public would pay for one of the same make, model, age and condition, not what a used-car dealer would offer. And for gifts, a local property-tax assessment is not the value unless it actually reflects fair market value on the date of the gift.

Where the tax code uses it.

• Inheritance. Section 1014 generally gives property acquired from a decedent a basis equal to its fair market value at the date of death (or the alternate valuation date six months later, if the executor elects it), and the same value goes on the estate tax return.
• Gifts. The value of a gift is its fair market value on the date of the gift, which sets whether a gift tax return is needed and how much exemption it uses. The recipient usually takes over the donor's basis, but if that basis is higher than fair market value at the time of the gift, fair market value becomes the basis for measuring a later loss.
• Sales and trades. Under section 1001(b), the amount realized on a disposition is the money received plus the fair market value of any other property received. The regulation adds that "only in rare and extraordinary cases will property be considered to have no fair market value".
• Charitable gifts of property. The deduction usually starts from fair market value, with reductions for some types of property and some recipients. IRS Publication 561 lists the factors that support a valuation: the cost or selling price of the item, sales of comparable properties, replacement cost and the opinions of professional appraisers.
• Pay in property. Under section 83, stock or other property received for services is income equal to its fair market value, less anything paid for it, when it vests, or at transfer if the recipient makes a section 83(b) election.
• Casualty losses. A personal casualty loss is measured by the drop in fair market value caused by the event, capped at the property's adjusted basis.

Valuing securities. For estate and gift purposes, a share or bond traded on an exchange or over the counter is valued at "the mean between the highest and lowest quoted selling prices on the valuation date" (26 CFR 20.2031-2(b)). If there were no sales that day, the value is a weighted average of the means on the nearest trading days before and after.

Hard-to-value property. Closely held businesses, real estate, art and collectibles have no quoted price, so the value rests on evidence, typically comparable sales, income-based methods or a qualified appraisal. Because the standard values the interest actually transferred, a minority stake in a private company can be worth less per share than the company as a whole, which is the basis for valuation discounts. A value reported on a gift or estate tax return can be challenged by the IRS, and the taxpayer carries the burden of supporting it.

Not the same as other "values". Replacement cost, insured value, book value and assessed value each answer a different question. Publication 561 gives a pointed example: the value an appraiser assigns to jewelry for insurance purposes is not its fair market value for a donation, because it does not reflect what a willing buyer and a willing seller would pay.

1. Fix the valuation date. Date of death (or the alternate valuation date), date of the gift, date of the donation, date of the sale or exchange, or the date property vests as pay.

2. Identify the market. Ask where this kind of property is normally sold to the public: an exchange for listed stock, the retail market for a car or household goods, the local real estate market for a house.

3. Gather the evidence. For listed securities, apply the high-low average. For everything else, use recent comparable sales, an income approach for a business or rental, and an appraisal where the rules require one or the amount justifies one.

4. Value the interest actually transferred. A half interest, a minority block of shares or property subject to a lease may be worth less than its proportional share of the whole.

For example: Omar inherits 200 shares of a listed company. On the date of his aunt's death the shares traded as high as $61.40 and as low as $58.60, so their fair market value is the mean, $60.00 a share, or $12,000 for the block. That $12,000 becomes Omar's basis. If he sells at $65 a share, his gain is $5 a share, or $1,000, whatever his aunt originally paid.

A gift works differently. Suppose Omar's mother gives him shares with a basis of $15,000 when their fair market value is $9,000. Because her basis exceeds the value at the time of the gift, Omar uses $9,000 to measure a loss and $15,000 to measure a gain. A later sale for $7,000 produces a $2,000 loss; a sale for $16,000 produces a $1,000 gain; and a sale for $12,000, between the two figures, produces neither.

Pros

• One standard across the estate, gift, income and charitable rules makes values comparable between taxes and between taxpayers.
• It points to observable evidence, actual sales between informed, unpressured parties, rather than to cost or to anyone's preference.
• For listed securities the regulations make the value mechanical and easy to verify.

Cons

• For property without a market price, the value is an opinion, and two competent appraisers can differ widely.
• The burden of supporting the number falls on the taxpayer, and a value can be challenged in an audit long after the gift or death.
• The hypothetical buyer and seller ignore personal value, so heirlooms and property with sentimental meaning are worth only what a stranger would pay.
• Getting it wrong in either direction costs money: too high inflates gift or estate tax, too low inflates the heir's future capital gain or invites a valuation penalty.