Defining Fair Market Value
Many of us remember sitting in Core Course and memorizing, yes, memorizing, the Federal definition of Fair Market Value (FMV). This was back when the Core Course exam was short essay, fill-in-the-blank, and multiple choice. Now the exam is multiple choice and memorizing the definition is not a prerequisite to passing the exam. However, if you were one of the people who memorized the definition, do not stop reading! FMV is probably a little bit more complex than you remember. First, there can be multiple definitions of fair market value depending upon the intended use of the report, and perhaps the state or province that you live in. Second, even though there is only one Federal definition of FMV, you should cite the definition of FMV differently depending upon the intended use of the appraisal report.
The Definition of Fair Market Value
Let's start with the federal definition of FMV and a brief history lesson. The first place to find guidance is within the IRS regulations.
A long time ago (pre-1985), the definition of FMV for a noncash charitable contributions was simply:
- ...the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts... (Treasury Regulation §1.170A-1(c)(2)).
The definition of FMV for estates was a slightly different and an expanded definition. It came from the Estate Tax Regulations:
- The value of every item of property includible in a decedent's gross estate under sections 2031 through 2044 is its fair market value at the time of the decedent's death, except that if the executor elects the alternate valuation method under section 2032, it is the fair market value thereof at the date, and with the adjustments, prescribed in that section. The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts. The fair market value of a particular item of property includible in the decedent's gross estate is not to be determined by a forced sale price. Nor is the fair market value of an item of property to be determined by the sale price of the item in a market other than that in which such item is most commonly sold to the public, taking into account the location of the item wherever appropriate. Thus, in the case of an item of property includible in the decedent's gross estate, which is generally obtained by the public in the retail market, the fair market value of such an item of property is the price at which the item or a comparable item would be sold at retail. (Treasury Regulation §20.2031-1(b)).
So, while the definitions were similar, the IRS argued that there were differences between the two definitions. In 1985, the IRS lost that argument in court. In Anselmo v. Commissioner, 757 F.2d 1208 (11th Cir. 1985), the 11th Circuit Court of Appeals affirming the Tax Court held that "there should be no distinction between the measure of fair market value for estate and gift tax and charitable contribution purposes." Therefore, when determining fair market value for any federal function, the full definition of fair market value applies. (Read more in the updated 2018-2019 ISA Core Course Manual, 2-3 through 2-8). This means that an appraiser must cite the full definition of FMV in their appraisal report. But, what is the best way to cite the definition?
ISA's Core Course Manual recommends the following language for your charitable donation reports:
- Fair market value is defined in Treasury Regulation §1.170A-1(c)(2) as, "The price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts." Treasury Regulation §20.2031-1(b) expands upon this definition, "The fair market value... is not to be determined by a forced sale nor is the fair market value of an item to be determined by a sale within a marketplace other than that in which the item would be most commonly sold to the public, taking into consideration the location of the item wherever appropriate." (See ISA's Core Course Manual, 12-20 (2018-2019 Ed.))
Remember that the effective date for a charitable contribution is the date of donation or anticipated date of donation. The date of donation is the date that the charity accepts legal title to the item. Often there is a deed of gift documenting this transaction. If possible, it is nice to include a copy of the deed of gift in the addendum of the appraisal report.
For estates, the Core Course Manual suggests the language:
- The definition of fair market value is set forth in Treasury Regulation §20.2031-1(b), which states that the "fair market value is the price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts. The fair market value of a particular item of property in the decedent's gross estate is not to be determined by a forced sale nor is the fair market value of an item of property to be determined by the sale price of an item in a market other than that in which the item would be most commonly sold to the public, taking into consideration the location of the item wherever appropriate." (See ISA's Core Course Manual, 12-20 (2018-2019 Ed.))
The effective date for a taxable estate is the date of death or the alternate valuation date (i.e., six months after the date of death). The appraiser should ask the client which date the estate is choosing. Generally, which date is chosen has more to do with stock valuation than the value of the personal property unless there has been a big change in market conditions.
As an aside, Anselmo also clarified what is meant by "the public." The court said that "the public" refers to "the customary purchasers of an item." The most appropriate purchaser of an item is not invariably the individual consumer. For example, the general buying public for live cattle would be comprised primarily of slaughterhouses rather than individual consumers. The fair market value of live cattle accordingly would be measured by the price paid at the livestock auction rather than at the supermarket. In this case, the Tax Court found the "public" for low quality, unmounted gems to be the jewelry manufacturer and jewelry stores that create jewelry items, rather than the individual consumer. The 11th Circuit affirmed this finding. So, knowing the appropriate marketplace for the items you are appraising is crucial to determining an accurate fair market value.
The definition of fair market value in Canada is similar to that in the United States, but differs slightly. The Canada Revenue Agency and the Canadian Cultural Property Export Review Board have endorsed this definition of fair market value:
- The highest price, expressed in terms of money, that the property would bring in an open and unrestricted market, between a willing buyer and a willing seller who are knowledgeable, informed, and prudent, and who are acting independently of each other. (See ISA's Core Course Manual, 2-5 through 2-6 and 12C-8 through 12C-10 (2018-2019 Ed).)
Note that in Canada, the "highest price" does not mean the highest price ever achieved. It means the highest price that is consistently achieved near the effective date of the report. Just as in the United States, the appraiser should be looking at the mode (i.e., the most common achieved price). However, in Canada if there is a "modal range" (i.e., a range of commonly achieved prices) the appraiser might choose a number at the top of that range. In the U.S. the appraiser would likely choose a number in the middle of that range.
One other difference is that in the U.S. the appraiser determines fair market value. However, in Canada, the appraiser estimates fair market value and the government determines fair market value.
Other Definitions of Fair Market Value
Appraisers should also know that different definitions of fair market value may exist for different purposes and that these definitions may vary from state to state or province to province. For example, in the four or five states where I have done divorce work the property was to be valued at "fair market value" per state statute. However, none of the statutes defined fair market value. So, what definition do you use?
The first step is always to ask the client or the client's attorney if there is a specific definition that they would like you to use, either from the state statutes or regulations governing divorce law or from the case law (i.e., the legal cases that have been decided and published). Sometimes they can email you the definition to use along with the appropriate legal citation. If you receive a definition, use it and the appropriate legal citation in the appraisal report. Note that #14 on the ISA Report Checklist requires not just the definition of the value sought but also the appropriate citation.
In my experience, however, a question about the state definition of FMV is often met with silence (you can hear crickets in the background). When this happens, the appraiser can suggest using the federal definition of fair market value used for estates, gift tax and charitable donations. In almost all instances where I have suggested this, the attorney has agreed. You can use either of the full definitions above. I usually omit the language about the "decedent's gross estate" in the second definition because it is irrelevant to a divorce situation.
The effective date for a divorce appraisal varies from state to state. In many states, it is the date of separation. However, I have used the date of separation, the date of inspection, or the date of the report depending upon the needs of the client and their attorney. Ultimately, it is up to the client's attorney to make a legal determination as to what the appropriate date should be.
Fair market value may also come into play in a tort suit (i.e., a lawsuit dealing with a civil wrong that might include a negligence or similar claim). In most tort suits the definition of fair market value will come from case law. Again, ask the attorney what definition you should use and get the appropriate citation. Also ask what the effective date should be.
- Kirsten Rabe Smolensky, JD, ISA CAPP