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If you own a car, how do you decide what it’s worth today?
Is it worth the original cost? Is it worth what a comparable replacement car would cost? Is it worth the dealer’s trade-in value, or perhaps what you could get selling it in a private sale on Craigslist?
Clearly, there is no single exact value for the car. This is the problem that fair market value sets out to solve.
Whether you’re dealing with an insurance claim, selling a valuable possession or looking to solve a tax question, there are multiple times when fair market value may matter to your finances. By understanding how the concept works, you can put yourself in the best position to assess your asset’s value correctly and achieve the most accurate and lawful result for your finances.
In this article, we’ll learn about what fair market value is, when you might need to use it, and what to look out for when choosing a fair market value for taxes or other purposes.
Defining fair market value
The fair market value of any asset is what someone would be willing to pay for it on the open market. If you were going to purchase something today, what would you expect to pay?
That’s the fair market value.
The easiest way to understand fair market value is by looking at the stock market. If you invest in single shares of stock, you have a quick and reliable method to determine fair market value.
You can check the stock’s listed price on a stock exchange to get a pretty good idea of its fair market value. Determining the fair market value of other assets isn’t always as simple.
Common uses of fair market value
Unless you’re an accountant, you’re most likely dealing with fair market value when the worth of your assets isn’t especially clear. In these cases, it’s helpful to know how fair market value will be determined — and why it’s an issue at all.
You may run into fair market value when dealing with taxes, real estate transactions, auto sales or insurance claims. It may come into play in other situations too, particularly for business accounting.
Every scenario is unique, but here are a few of the most common instances in which you might encounter fair market value.
Your annual taxes may include some fair market value calculations or estimates, depending on your financial activity in the past year. A common place to use fair market value when filing tax returns with the Internal Revenue Service is if you donated any items to a qualified organization. When you drop off a load of used items at Goodwill, you are responsible for determining the value of those items for a tax deduction. That value is based on the fair market value of each donation.
If your car gets hit by another vehicle, or anything else, it may need to be replaced. Many auto insurance policies offer the actual cash value of the car. Actual cash value, in this case, is the same as fair market value. And it isn’t what you paid for the car — it’s what you would get if you sold the car in a fair transaction before the damage. These terms may vary slightly by insurance policy, so make sure you read the policy carefully.
Real estate and auto sales
In a real estate transaction or car sale with a willing buyer and willing seller, the fair market value is a price that both sides agree is reasonable. In real estate, property taxes can also be based on fair market value.
Just remember that the fair market value of this property may not be the last sale price. Your aunt may be willing to sell you her old car for $100, but that doesn’t mean it has a $100 fair market value. The fair market value would be what the car is worth at an auto lot or in a normal private sale.
When dealing with investments, the fair market value of an asset in your portfolio is the current stock, bond or fund price in the markets. To determine the fair market value of publicly traded stock you average the lowest and highest selling prices for a given day.
Be fair when choosing fair market value
The nature of fair market value gives you some variability in deciding the value of an item or asset. Never lie about fair market value or skew your estimates too far in your favor. If you do, it could be considered fraud.
You may be most likely to run into an uncertain assessment of fair market value in a sale between family or friends. To find the most objective value, look at online resources and sellers to find a comparable item. The average price of a few similar items should help you land on a reasonable fair market value that you can use for your transaction.
It’s important to be as impartial and honest as possible when determining fair market value. If you have any doubt, it may be worth consulting with a professional financial adviser or attorney with a specialty in dealing with your current situation. You can also take certain assets to professional appraisers to take some of your own subjectivity out of the process.
Fair market value is a simple idea that could have big consequences for your finances if used improperly. It’s important to look fairly at the value of any asset you buy or sell, or else you could run into accusations of fraud. As long as you make a reasonable effort to get an accurate value, you should have little to worry about when it comes to fair market value.