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Fair Market Value

BY: JOSEPH M. CORNELL, CMA, ASA, ISA

ALL RIGHTS RESERVED 2005

“Fair Market Value” is, most often, an enigma to both appraiser and client alike. It is a term that causes confusion, misunderstandings, and a great deal of frustration.  Most people, when they encounter Fair Market Value as a term used in the appraisal industry and in appraisal reports reasonably construe its meaning to be fair market value, and when they discover it isn’t the same as fair market value a great amount of consternation can ensue.  So, to begin our discussion of Fair Market Value, let us defined the term.

“Fair Market Value” is a hypothetical concept used and developed by the Federal Government, originally, for use in determining tax liability. Its uses and applications have dramatically increased over the years.  Interestingly enough, it is the only term used by the Internal Revenue Service for calculating tax liability, whether pertaining to gift tax, income tax liability, estate tax liability, and including tax deductions for charitable donations.  “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 sell and both having reasonable knowledge of relevant facts.”  I have also seen this definition with the words “all the” placed in front of “relevant facts,” so the definition would read “all the relevant facts.” Personally, I prefer the use of the phrase “all the relevant facts,” as it helps eliminate certain kinds of arguments, which I do not find particularly worthwhile.

Fair market value is a hypothetical concept that is comprised of three words, i.e., fair, market, and value.  The definition of “fair” in fair market value is very much what the average person would think it to be, i.e., fair meaning egalitarian intention or action or common, “market” meaning the marketplace, and value meaning that estimates of value can be found by using events and frequency of the events in the marketplace as they pertain the similar property; the estimation of value ultimately comes from the experiences of others with a similar kind of properly under similar conditions; value is an expression of utility and use as expressed in marketplace transactions.

Fair Market Value is really quite different from other values, e.g., Replacement Value, Marketable Cash Value, etc., in that the concept of ownership and the enjoyment of retained benefits of a specific property, which includes increases in value, present and future, if any, is integral and inextricably tied to Fair Market Value. The concept of Fair Market Value was developed to measure and quantify the value of taxable properties for which the joys and advantages attached to ownership are retained.  Fair Market Value was specifically designed to express the value of properties held or unsold. Properties held in an estate, which are taxable, and which are sold, are taxed on the amount of money actualized from the sale of the property.  This is because the IRS has decided that the sale price of a property, so long as the transaction is an arm’s length transaction, is the most compelling evidence of its Fair Market Value.  Consequently, properties, which are considered to be taxable, but are unsold are taxed on their unsold value, or held value.  The Federal Government also developed a concept known as the bundle of rights associated with the ownership of the particular property.  This bundle of rights includes rights to sell a particular property, or the right to not sell a property, i.e., hold that property unsold, and to continue to enjoy the bundle of rights attached to the ownership of a property.

Fair Market Value is not intended to be closely associated with any of the other values, e.g., Actual Cash Value, Replacement Value, Liquidation Value, etc., except as defined by Treasury Regulation Sec. 20.2031-1[b]. Fair Market Value was never intended to be determined by forced liquidation price.  In addition, Fair Market Value must be determined in estimating the sale price that an item might bring in the market in which such property is most commonly sold to the public, and in no other.  If the property is generally sold to the public in the retail marketplace, the Fair Market Value of a similar piece of property is the price at which the property, or similar property would be sold at retail.

It is each Appraiser’s obligation to arrive at the apposite value conclusion irrespective of which value is chosen.  The apposite value estimation of all Fair Market Value appraisals is dependent upon the accurate determination and use of the most active and relevant market through which to arrive at his/her value conclusion.  This requisite marketplace is that specific market in which such property is most likely/often sold to the public.

The determination of the most relevant marketplace is not always easy, and remains the province of the expert appraiser.  It is important to understand that the courts recognize that the market in which such property is most commonly sold to the public is not always the primary market and that the “public” is not necessarily confined to individual buyers.  For example, the Fair Market Value of a large herd of sheep is not determined by what retail food stores charge for their meat, but rather, what the food processing facility that buy sheep for slaughter pay for sheep on the hoof.  This does not mean that the value of a single unit, in this case one single animal, is any different than the value of 100 sheep, based on a per pound value calculation, and decided by multiplying the pounds of the single animal by the value of its poundage to the slaughterhouse.

Marketplace analysis is pivotal for the expert appraiser.  Marketplaces can serve many different levels of purchasers simultaneously.  Auction houses often cater to both wholesale and retail buyers at the same auction.  Prices paid at auction can indicate values at different levels, e.g., wholesale retail, etc. Auctions, which are conducted at large auction houses, which are well advertised and cataloged might be a suitable place to determine retail prices, if the appraiser is confident that the buyer of a particular item is a retail customer, not a wholesale customer.  Conversely, certain types of marketplaces, normally considered to be places where retail transactions take place, can, also, be the locations where wholesale market transactions take place.  Wholesale buyers often acquire merchandise for resale by buying at retail establishments.  This can take place where the owners of particular types of retail establishments do not have the requisite knowledge to properly price a particular property in such a manner so as to take full advantage of its full resale potential. This is very common in the antique/collectible business. It is also common in situations where large retailers liquidate inventory at liquidation prices that are purchased by smaller retailers for resale in a marketplace often times unavailable or considered to be impractical to the larger sellers. For example, a particular retailer in a small-town may decided to liquidate that part of his inventory, which remains unsold to his local clientele, but is purchased at distressed prices by a retailer in the larger marketplace, who believes he can sell this inventory to his customers at an acceptable profit. Large department stores often liquidate inventory, because of seasonal changes or for one reason or another, which is then purchased by other retailers for sale in other markets. This is particularly true of individuals who sell on a regular basis on the international marketplace covered by eBay.  Another example of this is that wool sweaters sell well in some climates during winter time, but as the weather warms up the demand for such items dwindles; such items can often be purchased at large department stores at liquidation prices and sold in Alaska, where  preparation for cold-weather is not far from any person’s plans, at retail prices all year long.

The “Highest and Best Use” of a property is the legal, feasible, most probable, and reasonable use of a property, which results in its highest value. When considering personal property, this is very often the purchase or sale in the most appropriate market. The retailer, mentioned in the prior paragraph, who buys at department store liquidation sales, and sells on eBay at a profit, is a perfect example of this principle. The amount of money received for an item can very depending upon the marketplace in which it is sold, and the client is entitled to the highest and best use of the item being appraised.  Where once, more commonplace household goods would sell best in a local tag sale, now, the same item could, depending on what it is, bring substantially more money on eBay.  A perfect example of this is a pocket watch of collector grade, which in the local market of a small-town would sell for about $200 and take 90 days to sell, whereas on eBay at would bring $450 in 10 days.  Knowing this information is critical for the appraiser writing a Fair Market Value appraisal.  Highest and best use determines the appropriate market level in any appraisal assignment.

Fair Market Value is often used in equitable distribution settlement matters. It is important to realize that the goal is for the equalization of the property that goes to the parties. If one person gets money and the other person gets the property, it is important that each pile be equal. If one of the items was purchased for a very low price compared to its actual value as of the effective day of the appraisal, that fact is immaterial. The appraiser must appraise an unsold item at market, which is retail, unless otherwise specified, and its value must be as of the effective day of the appraisal. In divorce matters this is often times one of the most difficult things for the party that is to retain certain property to understand; it is, also, the biggest problem for families trying to retain family assets such as ranches or business that have become very valuable over the years, but were started from scratch or were purchased for relatively small amounts of money many years in the past.

In conclusion, Fair Market Value is a hypothetical concept of value used by courts and the Federal Government in the valuation of properties that are held and remain unsold at the time of valuation.  A property’s Fair Market Value is the amount of money that would be obtained, including any buyer’s premium, taxes, etc., once an item has been paid for in-full by the buyer, rather than retained by the seller, from the sale in an arm’s-link transaction, between willing and knowledgeable parties in the marketplace where the item is most often sold to the public, at retail, resulting in its highest and best use.