Fair market value: Overview, definition, and example
What is fair market value?
Fair market value (FMV) refers to the price at which an asset or property would be sold in an open and competitive market between a willing buyer and a willing seller. The seller is under no compulsion to sell, and the buyer is under no compulsion to purchase, both having reasonable knowledge of the relevant facts. FMV represents an objective value, based on what the market dictates under normal conditions, without any external influences like undue pressure or distress sales.
In the context of business, real estate, or tax law, fair market value is often used to determine the value of assets for purposes such as taxation, sales, or financial reporting.
Why is fair market value important?
Fair market value is important because it provides a standard, unbiased way to determine the value of an asset or property. It ensures that both buyers and sellers have a clear understanding of the asset’s worth under normal market conditions. FMV is especially important in transactions such as mergers, acquisitions, or property sales where both parties need an equitable basis for agreeing on a price.
In legal and financial contexts, FMV is often used for tax reporting, determining insurance claims, or assessing compensation in litigation. It provides transparency and fairness in situations where the market is the deciding factor in establishing value.
Understanding fair market value through an example
Imagine that Company A wants to sell a piece of equipment to Company B. To determine the price, both companies will consider the fair market value of the equipment, which is based on what similar equipment would sell for in a competitive market between unrelated buyers and sellers. If similar equipment is selling for $50,000 in the market, the FMV of the equipment would be considered $50,000.
In another example, a real estate agent helps a homeowner determine the fair market value of their home. The agent looks at comparable properties in the neighborhood that were recently sold and adjusts for factors like the home’s condition and size. If the comparable homes sold for around $300,000, the FMV of the homeowner's property might also be around $300,000, assuming there are no unique circumstances that would affect the price.
An example of fair market value clause
Here’s how a fair market value clause might appear in a contract:
“In the event of a sale of the property, the purchase price shall be determined by the fair market value of the property at the time of sale, as agreed upon by an independent appraiser selected by both parties. If the parties cannot agree on the appraiser, the value will be determined by an appraiser appointed by the local real estate board.”
Conclusion
Fair market value is a widely accepted measure of value used in a variety of contexts to ensure transparency, fairness, and objectivity in transactions. By considering the price at which an asset would sell in an open market, FMV helps ensure that both parties are dealing with an asset's true value, free from external pressures. It plays a key role in everything from business transactions to tax assessments, providing a solid foundation for making decisions and negotiating prices.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.