Fair market value

The fair market value of property is the price at which it would change hands between a willing and informed buyer and seller. The term is used throughout the Internal Revenue Code, as well as in bankruptcy laws, in many state laws, and by several regulatory bodies.^[1]

In litigation in many jurisdictions in the United States the fair market value is determined at a hearing. In certain jurisdictions, the courts are required to hold fair market hearings, even if the borrowers or the loans guarantors waived their rights to such a hearing in the loan documents.^[2]

FMV is often used for taxation purposes, determining the value of charitable donations, estate planning, and other financial transactions. The specific methods used to determine FMV may vary depending on the type of property or asset involved.^[3]

Fair market value is subjective and can fluctuate based on market conditions, supply and demand, location, and other factors.^{[citation needed]}

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Let's say I run some type of sheep farm, maybe some type of wool producing business. And in year one, I go out there, I buy a bunch of sheep, and I put them on some land. And I go and I buy the sheep for $1 million. And I buy the land for $1.2 million. So I have $2.2 million in assets. Nothing confusing there. Now, let's go to year two, and think about how we want to account for the sheep and the land. So one way we could say is, oh look, the sheep are still there. The land is still there. I paid a $1 million for the sheep and they're all still there. So I'll put on my books that the sheep are still $1 million. And I paid $1.2 million for the land. So I'll put on my books that the land is $1.2 million. So in this situation, I've accounted for the sheep and the land based on their historical cost. So let me write this down. This is based on historical cost. Now, this is a legitimate way to account for things, especially if there's no other way to really think about what my sheep or my land are worth. I'd say, look, this is what I paid for them. Now let's say that there is an active market in sheep, and you can get a sheep appraiser to come over to your farm and tell you what your sheep are worth. And your sheep appraiser comes and says, wow, your sheep are looking good. There's been a big-- I don't know-- sheep epidemic in another part of the country. So there's a sheep shortage. So your sheep are actually worth a lot more than they were last year. And they say, I think your sheep are now worth $2 million. So you say, hey, wow, the market value of my sheep is $2 million. So you could say, well, instead of putting $1 million there, let me put $2 million. Let me put $2 million for my sheep. And let's say that the land is also appreciated. A highway's gone by and someone wants to build a development nearby. So the fair value of your land has also gone up, maybe it's also $2 million. So both of these. So this is $2 million. And this is $2 million. So this right over here, you could view as the market value or the fair value of your sheep. Now, either one of these are legitimate ways of accounting, but it's good to know the difference. This is historical cost accounting. This is fair value accounting. In general, most accounting standards boards want people to report the fair value or to market value as frequently as possible. And it's very easy to do if there is kind of a market in that. Or you can get an appraiser in and they can give you a pretty good estimate of what these things are worth. If that isn't around, or if it's just inefficient to do it, then you'd probably want to do the historical cost method. So that's all the difference. Historical cost, how much you paid for it. Fair value, what's the current market value today. So they sound like very fancy words, but it's a pretty simple idea.

Definition

United States

The fair market value is the price at which 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)).^[4]

Canada

Fair market value is not explicitly defined in the Income Tax Act. That said, Mr. Justice Cattanach in Henderson Estate, Bank of New York 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.^[5]

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

^ to wit, Internal Revenue Service Notice 2005-43
^ Jenkins Jr., W. Scott; Alissa A. Brice; Ryley Carlock & Applewhite, PC (20 April 2014). "The Arizona Court of Appeals Holds the Right to a Fair Market Value Hearing Cannot be Waived in a Deficiency Action". The National Law Review. Retrieved 5 May 2014.
^ "Fair Market Value (FMV): Definition and How to Calculate It". Investopedia. Retrieved 2023-05-25.
^ United States v. Cartwright, 411 U.S. 546, 551 (1973) ("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.").
^ "Fair Market Value" Archived 2014-08-06 at the Wayback Machine Canada Revenue Agency Dictionary. Retrieved 20 May 2014.

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