In its simplest sense, fair market value (FMV) is the price that an home would sell for on the open market. Fair market value represents an impartial valuation or assessment of worth, regardless of individual buyer and/or seller circumstances. For example, it doesn’t matter how much money the seller needs to pay off the loan or recover renovation costs. It also doesn't matter how much a specific buyer may be able to afford.
Outside of general curiosity, there are three main reasons why it may be necessary to determine the fair market value of a home.
For Transfer of Ownership Purposes
Knowing fair market value allows a homeowner to assess the value of their home to make sure they can computer what a reasonable value is for their property at a point in time. Some examples of situations where the need may arise to determine fair market value of a property include;
A home is being priced for sale
The government is exercising eminent domain
A property is involved in a settlement such as a divorce
A home is tied up in the probate process
For Tax Purposes
Tax authorities may want to know that real property is sold at fair market value. This is especially true for transactions between people not dealing at arm’s length property transfers. Municipal property taxes are often assessed based on the fair market value of the owner’s property. Fair market value also comes into play when someone is trying to determine the value of inherited property or property sold through the probate process. Tax authorities need to ensure that the credit given is for the true fair market value of the property.
For Insurance Purposes
Fair market value is often used in the insurance industry when it comes to determining appropriate coverage or paying out insurance claims. For example, when an insurance claim is made as a result of a house fire, the insurance company covering the loss will often only cover the amount up to the fair market value.
Since determining the fair market value of a property is not as easy as just plugging numbers into a spreadsheet, the IRS has a list of accepted methods that can be found here. There are five ways to determine fair market value for real estate purposes.
Comparative Market Analysis
One of the more common methods that real estate professionals use to determine the fair market value of real property is to compare the property in question to comparable properties currently on the market or other comparable properties that have recently sold. This is called a comparative market analysis (CMA). A licensed real estate agent commonly performs a CMA pulling in current asking prices for comparable properties and recent selling prices of comparable properties to determine a reasonable estimate of what a property might sell for if placed on the market today. To try to get as accurate as possible, the agents will look at a continuum of time that the prices have been stable looking back from today being cognizant of periods of time that the market may have shifted up or down. It is also important the comparable properties are as similar as possible in square footage, number of bedrooms, finish level and condition as well as sold under similar conditions. For example, foreclosure sales of comparable properties are not accurate assessments of the value of a property not being sold at foreclosure.
Professional Appraisal
Another way to estimate the fair market value of a property is to hire a real estate appraiser. A real estate appraiser is a certified professional with training and experience concerning the many factors that determine property value. Most lenders require a professional appraisal before approving your loan to purchase the property. When real estate appraisers value property, they use slightly more defined models of comparative market analysis.
Replacement Cost
Although not necessarily fitting for determining real estate list prices, Insurance companies often use this third method. If the value of a house has changed over time, the cost of replacing it might be used as an indicator of the fair market value. For example, If a home you bought for $300,000 burns down, because of increases in land value or construction costs, rebuilding the same home may now cost $350,000.
Selling Price
Selling price, according to the IRS, is the actual selling price of the property that is received by another party. It’s one of the easiest ways to get a sense of the fair market value of a property. After all, if the transaction is arm’s length, then the selling price is what a buyer is willing to pay for the property on the market. However, the selling price will only give an accurate idea of fair market value if the transaction takes place near the time the fair market value is needed. As you can imagine, the selling price of a property that was sold ten years ago tells us little about the fair market value in today’s market. Even if the property is sold very recently, many factors can also lead to a property being sold for less or more than fair market value. This means that a property’s selling price is not always an accurate reflection of the home’s fair market value.
Valuations by Third-party Websites
The most visible method to home owners is the third-party online valuations that make estimates using their own proprietary formulas based on recent local sales on Zillow, and public tax records, such as Zillow's 'Zestimates'. For example, Zillow makes calculations, which it calls “Zestimates,” regarding the fair market values of property. Although this data is easily accessible and may satisfy the curious owner, its accuracy may not be as good as other methods as it doesn't typically consider some of the key factors affecting a homes value such as finish, condition, floor plan popularity, etc.
Identifying the best approach for determine fair market value must take into consideration the purpose. If you need to figure out the fair market value for your home, feel free to give Renee Hahn a call and she can guide you through the decision making process and introduce you to resources that can help you.
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