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.

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

Fair market value is the price that real property 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.” In this article, we’ll be examining what FMV means as it applies to real estate.

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

In other words, if you sell your home in an arm’s length transaction to a stranger (anyone you don’t share a financial interest with) who makes the highest and best offer, the sale price would be considered the FMV by definition.

This distinction becomes important when the value of your property is in dispute. Common situations where FMV might become crucial are during a real estate dispute or a disagreement with a homeowners insurance company about the value of a destroyed home. In these cases, you may need to offer proof to support your arguments about the value of your home.

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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. These values may give you a good initial indication of the fair market value of your home but are ultimately not exact.

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 you think about FMV, it’s important to remember that it’s the value of the property at a particular point in time.

Fair market value is a legal term of art, meaning that the legal definition differs from the way you might use the term conversationally.

Used 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 a non-arm’s length transaction.

A parent might be tempted to make a sale to a child at an artificially low price to avoid capital gains and gift taxes. Potentially, the child in this scenario might benefit from lower property taxes should their municipality decide to reassess property values.

Used By Local Governments

How much you pay for the home affects how much you’ll pay in property taxes. This is 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 the expected FMV, it raises a red flag with local officials, who will look into whether the homeowner is trying to avoid additional taxes. If they suspect you’re trying to dodge taxes, local officials may alert the IRS.

Used By Insurance Companies

The term is also used to evaluate homeowners insurance claims, where homeowners might be tempted to undersell 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 to under-report other upgrades either mistakenly or to avoid higher premiums.

Yet, when they make a claim, homeowners will want to be fully reimbursed for their losses. When a home is destroyed, homeowners will naturally want to collect the maximum amount possible from their policy. To make sure you’re covered, it’s important to report changes or upgrades accurately when updating your policy.

Another potential danger for homeowners is significantly overstating the value of your home. This could cross a line into insurance fraud. You’ll want to make sure your claims are backed by proof of value to avoid any issues.

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 point in the past, a real estate 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, their answer will likely be based on how much they could get for their house if they sold it now. However, one idea of value isn’t always accurate when you consider the different purposes and where you might need to demonstrate your home’s FMV.

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. With your listing agent, you’ll set an asking price based on comparisons between your property and similar recently sold properties in your area. Your agent will consider factors like age, size, updates or renovations made. You may hear these competitive properties referred to 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.

The 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 is the grounded 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.

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

Let’s consider two contrasting examples of transferring property in a non-arm’s length transaction and how they can differ from a tax perspective.

For example, number one, 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 that time, they could save significantly without violating the Internal Revenue Code.

In a contrasting scenario, if a parent “sells” their $2 million home to their child for $100,000, the IRS would identify this sale quickly and consider it a gift instead of a sale. The parents will have to pay the applicable gift taxes.

Appraisal Value

As we discussed above, an appraiser will assign an appraised value to your home. 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 accurate value of the home.

Occasionally, appraisals can come in lower than expected. For example, when a neighborhood is experiencing a rapid increase in home values. This is because the appraiser is relying on past sales when the market is rapidly evolving. In this situation, 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 a percentage ranging typically between  50% 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 the government is asking about your home’s value, they are likely trying to assess if the property was transferred at the correct value so they can collect appropriate taxes. If an insurance company is asking, it’s likely to accurately assess self-reporting of your home’s value for the purposes of a relevant claim or to estimate your insurance premium.

No matter what the situation, understanding a home’s worth in different contexts can help you when it comes to buying or selling a home. 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 the  current market value.

Hanna Kielar

Hanna Kielar is a Staff Writer for Rocket Companies with a focus on personal finance, automotive and personal loans. She has a bachelor's degree in professional writing from Michigan State University.

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