How to determine fair market value (FMV)

The FMV of a home, business, or any other type of asset is the price at which it would be sold on the open market during normal conditions. According to the Internal Revenue Service (IRS), this means a property would change hands between a willing buyer and seller, who have agreed upon a price with full knowledge of relevant facts and without a compulsion to buy or sell. 

Fair market value vs. market value: What’s the difference? 

FMV is a hypothetical value—it is determined based on the estimated amount a buyer and seller would likely agree upon under “normal” conditions. Market value, by contrast, is the price at which a property will actually sell for. While FMV and market value are closely related and can work out to be the same, the latter is subject to unpredictable real-world scenarios. 

For instance, if a seller isn’t able to make their mortgage payments, because they lost their job or have an emergency in the family, they might be compelled to sell the house below its FMV to get it off their hands as quickly as possible. Or, if a buyer wants to build a home in the last lot in an up-and-coming neighborhood, they might be persuaded to pay above FMV to secure that dream spot. 

Basically, any time either party responds to outside pressures or acts at all irrationally while buying or selling a home, the home’s price point is subject to stray from its FMV.

Because markets are constantly fluctuating and there are so many elements that affect a home’s value (location, size, age, land, architectural style, finishes, etc.), there is no one specific formula to calculate FMV. 

That being said, one way to start is by looking at how property values have changed over time for properties similar to yours. 

1. Look at the actual change in property value that comparable properties have experienced. You can calculate this by looking at listing histories. 

2. Consider the price you paid for your property, or the price that the current owner paid for it. 

3. Apply the average value change that you assessed to that price. 

If you’re looking for an accurate FMV estimate, it’s best to have your home appraised by a professional, third party appraiser.

While FMV can sometimes feel somewhat theoretical, given the unpredictability of the real world, understanding this measure of your home’s value is a key first step to entering the real estate market. More than that, FMV will have very real effects on your insurance policy and taxes relating to your home, no matter what you paid for it. 

• Selling your home: When it comes time to sell your home, determining its FMV is an important first step. Once you have a sense of what your property would go for on the open market, it can be useful to work with a real estate agent to identify whether there are improvements that could be made to increase your home’s value and ultimately put it on the market at a higher rate. 

• Property tax: No matter what you paid for your home, its FMV will be used for all tax purposes. As a homeowner, you’ll have to pay a municipal property tax determined by your home’s FMV every year. 

• Gift or estate tax: If a property trades hands as a gift or inheritance (say, if your grandmother leaves you her house in her will, or your parents choose to help you out by selling you their $500,000 home for $150,000), it is subject to a gift tax or estate tax based on the property’s FMV. 

• Insurance: Your insurance company will use your home’s FMV, along with a liability assessment, to determine your insurance rate. And if your home is robbed or damaged in a natural disaster (knock on wood), your insurance claims and payouts will be based on FMV as well. 

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