What Is Fair Market Value (FMV) And How Can You Prove It?

Your home is likely your most valuable asset, but how much is it worth at any given time?

The truth is your home has many different values and those values can change from day to day, amid the wide variety of market forces buffeting your property and your local area. It also depends on who’s asking and for what purpose.

Let’s take a look at what the FMV of your home is and how it compares to your home’s other values.

Fair Market Value Definition

Fair market value (FMV) is the determined value of a home and what it’ll sell for in an open market. Typically, a willing seller and willing buyer will agree on a property’s FMV, using their reasonable knowledge of the property in the transaction.

In an open market, the market value typically uses the FMV to determine the selling price. Therefore, fair value is the measure of an asset's worth, and the market value is the price it will go for in the open marketplace. For example, if the fair market price of a home is $200,000 but the home is in an up-and-coming neighborhood, the market value may be closer to $225,000 due to many people wanting to live there. In other words, the market can drive the value higher than that FMV.

What Is The Fair Market Value (FMV) Of A Home?

The IRS defines fair market value as the price that real or personal property – in this case, we’ll focus on real estate – would sell for on the open market between an unrelated, willing buyer and willing seller acting freely, with knowledge of relevant facts. The IRS refers to these types of sales as “arm’s length transactions.”

This type of transaction assumes that sellers will always try to maximize their sales price — we’re ignoring the value of contingent-free contracts to sellers, which might justify accepting a slightly lower offer – and buyers will always try to minimize their purchase price.

Put another way, you sold your home in an arm’s length transaction if you sold it to a stranger – anyone with whom you didn’t share a financial interest – who made the highest and best offer. Under those circumstances, your sales price is the FMV by definition.

But if you’re on either side of a “non-arm’s length transaction,” or in a dispute with your homeowners insurance company about the value of a home that was destroyed, you may need to offer proof to support your arguments about the value of your home.

Fair Market Value Vs. Home Value Calculators

If you’re a homeowner looking to sell your home for the maximum price possible, you can get an initial sense of what your home is worth by using an online home value calculator. You’ll want to confer with your listing agent to set the right asking price for your circumstances and local market conditions.

How Is Fair Market Value Used?

The value of real estate constantly changes depending on a wide variety of macroeconomic, political and local factors. So, when thinking about FMV, it’s important to remember that it’s the value of property at a particular point in time.

Fair market value is a legal term of art, meaning that it has a specific definition in law that differs from how the term is used conversationally.

By The Internal Revenue Service (IRS)

The IRS takes a close look at non-arm’s length transactions to see if the transaction – for example, a parent’s sale of a home to their child – was made to avoid gift, estate or capital gains taxes.

From the IRS’s point of view, “legally” means that they want to be sure the transaction wasn’t undertaken between related parties to avoid taxes in what they call a non-arm's length transaction.

Continuing with our example of the sale of a home between parent and child, a parent might be tempted to make the sale at an artificially low price to avoid capital gains and gift taxes while the child might want to benefit for lower property taxes should their municipality decide to reassess property values.

By Local Governments

How much you pay for the home will eventually affect how much you’ll pay in property taxes. That’s because most tax assessors consider FMV when determining the assessed value of the home. Local governments use a variety of methods and factors to determine this value. The FMV of your home will be modified up or down, depending on state and local laws, applicable exemptions and the methodology chosen.

If a home was sold at a price clearly below expected FMV, it raises a red flag with local officials, who will look into whether the homeowner is attempting to avoid taxes. They may alert the IRS.

To find out how property taxes will impact your monthly mortgage payments, use our home affordability calculator and enter your future home’s ZIP code.

By Insurance Companies

The term is also used to evaluate homeowners insurance claims, where homeowners might be tempted to under- or overstate their home’s FMV, depending on the circumstances. For example, homeowners might be scrupulous about making sure big-ticket items are adequately insured, but they tend not to report other upgrades out of negligence or a desire to avoid higher premiums.

Yet, when the time comes to make a claim, homeowners will want to be fully reimbursed for all their losses. When a home is destroyed, homeowners will naturally want to collect the maximum amount possible from their policy.

However, homeowners who significantly overstate the value of their home can cross a line into insurance fraud. To protect yourself against that charge, make sure your claims are backed by proof of value.

How Can You Prove A Home’s Fair Market Value?

In general, the only time you’ll be asked to demonstrate the FMV of a property is if it comes under scrutiny because of a tax or insurance dispute. At that point, you might be asked for proof that the price received or paid wasn’t artificially high or low.

Here are two ways to prove your home’s FMV.

Get A Comparative Market Analysis (CMA) Done

A real estate agent can create a comparative market analysis to help homeowners understand what homes are selling for in their market. Essentially, it’s a deep dive into what homes are selling for and the condition they are in.

CMAs can be performed historically as well. In other words, if you need the FMV for a time past, an agent can help.

Order A Market Value Appraisal

You can also hire an appraiser to determine a home’s value.

A home appraiser will look at comps and will likely inspect the property in question. After completing their research, the home appraiser will assign an appraisal value to the home.

If you’re arguing with the government about taxes or an insurance company about a claim, an appraisal supporting your valuation will help.

All My Home’s Values: A Glossary For Homeowners

If you ask a homeowner how much their home is worth, most will think about how much they’d get for their home if they were selling it. But that’s imprecise language, given all of the various purposes for which you might need to demonstrate your home’s FMV to resolve some sort of dispute.

Let’s take a look at all the different values one home can hold.

Asking Price

Where to set the asking, or listing, price is more of an art than a mathematical calculation. In consultation with your listing agent, you’ll set an asking price based on comparisons between their property and similar, recently sold properties in your area, specifically on things like age, size, updates or renovations made – also known as “comps.”

Your real estate agent will have a good sense of your local real estate market and how you should price your property. They’ll take into account how quickly you want to move, the characteristics of the property and how many buyers are interested in the type of property you own.

Asking price should reflect FMV as well as your strategy for selling the home. If it’s a strong seller’s market, agents may advise you to set your price on the low side, knowing that a bidding war will erupt and the price might go higher than the seller imagined. On the other hand, in a buyer’s market, setting the price at a reasonable level is crucial to attracting the few interested buyers.

Purchase Price

If the asking price represents the seller’s aspirations, the purchase price reveals reality. Ideally, sellers and buyers should be equally empowered during the process. Once agreed upon, the purchase price shows exactly what FMV is at that moment, assuming the parties are negotiating at arm’s length.

Market Value

Market value is an amorphous term that approximates FMV. In other words, sellers and their agents decide what the market value of their home is, and the market decides whether they are correct. In an ordinary sale between strangers, market value and fair market value are the same thing.

It’s when homeowners transfer property between family members or other interested parties that market value diverges from FMV. The IRS scrutinizes these to make sure the transaction was fairly priced at the time and all applicable taxes were paid.

Let’s consider two situations. Let’s assume a parent wants to transfer their home to their child to avoid estate taxes. If they decide, during a deep recession and an ice-cold housing market, to make the transfer at the FMV at the time, they could save significantly without violating the Internal Revenue Code.

On the other hand, if a parent “sells” their $2 million home to their child for $100,000, the IRS will immediately see that this was a gift pretending to be a true sale. The parents will have to pay the applicable gift taxes.

Appraisal Value

As we discussed above, an appraiser will assign an appraised value. If you're applying for a mortgage, the appraisal value is a limit on how much a mortgage lender will allow you to borrow. The appraisal assigns a monetary value to your home to let you know you’re making a good offer and to let your lender know the value they can expect to recoup should the home be sold after foreclosure.

Appraisals can come in low when a neighborhood is rapidly enjoying an appreciation in home values. That’s because the appraiser is relying on past sales – even values from a month or two prior can be lower than current prices.

Assessed Value

Your assessed value is the base value assigned to your home by the local taxing authority. It’s typically a percentage ranging between 60% and 100% of your home’s market value.

When you buy a new home, you’ll likely enjoy its current assessed value until your municipality decides to undertake a new assessment for the entire jurisdiction. At that point, your purchase price is likely to be taken as its assessed value, subject to local laws regarding exemptions.

To get your current assessed value, contact your local property clerk or recorder’s office.

Cost Basis

When you sell your home, your cost basis in the home will determine whether you owe capital gains taxes on your sales proceeds. Your cost basis is your purchase price plus any capital improvements you made to the property.

For example, let’s assume that 20 years ago you purchased a $200,000 home. Five years ago, you renovated your kitchen for $50,000. Now, you want to sell it for $500,000.

Your cost basis in the home is $200,000 + $50,000 = $250,000. When you sell, you’ll realize $250,000 in proceeds that could be subject to capital gains tax, if they exceed the personal home exemption of $250,000 per individual or $500,000 for a married couple filing jointly.

The Bottom Line: One Home, Many Values

Your home’s value depends on who’s asking and why. In general, if a government is asking, it’s because they suspect you transferred your property at an artificially low price to avoid taxes. If an insurance company is asking, it’s likely because they suspect that your claim artificially inflates your home’s value.

If you’re a home buyer looking for a home you can afford, your real estate agent will be able to help you make an informed offer that reflects current market value.

Ready to find that affordable home? Apply online now and start looking!