There’s a term in real estate that’s relevant to buyers and sellers alike, which is fair market value. Fair market value lets you know how much a home would theoretically sell for in an ideal world where logic was the determining factor. Basically, the fair market value would be what a seller would get if they were in no hurry and waited for the perfect offer.
We all know there are a number of variables that actually interfere with transactions, and both buyers and sellers negotiate until they can come to a price they agree on.
While negotiation is a big part of buying a home, understanding fair market value is also relevant.
There are a few things fair market value isn’t. It isn’t solely what either party thinks the value of the home is, nor is it just the appraised price. It’s also not the tax value. These factors can be part of the fair market value, though.
Calculating Fair Market Value
There isn’t a specific fair market value formula, and homes are assets that are subject to the ups and downs of the market. Primarily, supply and demand play a role in the value of a home.
Some of the elements that can be considered when calculating fair market value are:
- Current market trends
- A comparative market analysis of other properties that are similar and in the same area
- Calculating the fair market value based on a price per square foot
Any one of these things can be used in conjunction with one another to start to come to a fair market value.
Figuring out the fair market value is something real estate agents are experts at, which is one of the reasons people opt to hire them rather than trying to sell their homes independently. It’s important to have knowledge of the facts of the property itself but also what’s happening in the local real estate market and even what’s happening on a larger level in the economy.
How Is Fair Market Value Used?
Typically, once the fair market value is calculated, then that’s used to determine the home’s selling price, but with caveats. For example, if the home’s fair market value is $250,000 based on market trends, but it’s in a very popular neighborhood, the asking price might go up to $300,000.
There are other ways outside of real estate that fair market value might be used, and also other applications related to real estate.
For example, the property tax that you owe to your municipality is probably based on the fair market value of your home. Your FMV tends to go up the longer you’ve owned your home, so your property taxes go up as well.
The value of your home might also affect tax credits, your gift tax, and your estate tax.
If you were to gift your home or make it part of an inheritance, then the person you’re giving it to may have to pay taxes based on the fair market value.
If that person then sells the home and they get more for it than the value it was assessed at when they inherited it, they have to pay capital gains tax on the difference between what they sold it for and the fair market value.
Fair market value is a term used in insurance as well. If your property is damaged, the amount you receive to pay to repair it can be based on fair market value.
If your home is affected by a natural disaster and it’s evaluated below FMV, you might not get as much compensation.
There are a lot of ways fair market value can be used, but again, it’s not an exact formula. It’s often based on several key metrics simultaneously to figure out how much a home might be worth at any given time if it were to go on the market.