Fair Market Value
“Fair market value” is one of the most commonly used terms in appraisals. Fair market value appraisals are required for all work submitted by a taxpayer to the Internal Revenue Service – for estate taxation; for donations of art given to qualifying charitable institutions; and, for gift tax purposes, when there is a tax to be paid for gifts given to a family member or friend which are worth more than $5,000.
The IRS has defined fair market value as “The price that property would sell for on the open market. It is the price that would be agreed on by a willing buyer and a willing seller, with neither being required to act and both having reasonable knowledge of the relevant facts.”
In other words, the fair market value is the price which would be paid by the purchaser, and not necessarily the price for which a similar object is “offered” for sale in a shop, since there is no guarantee that a work of art being offered by a dealer would ultimately be purchased at that price. There must be a sales record to substantiate the fair market valuation.
There are three essential components to fair market value: first, the willingness on the part of both the buyer and the seller to enter into the commercial transaction; second, the lack of compulsion forcing one or the other either to buy or to sell the property; and third, that both parties have full knowledge of all the facts concerning the object being offered for sale.
The fair market value, according to the IRS, is the amount of money the buyer would pay for the object. This may not necessarily be the amount of money the seller receives. For example, at auction, buyers frequently pay a buyer’s premium to the auction house; and the seller frequently has to pay a commission to the auction house or to a dealer brokering the art. This means the proceeds of the sale received by the consigned will be less than the actual sales price.
Fair market value is also founded on the premise that the works are sold at an “orderly sale.” This means that the auction house, or the dealer acting as an agent for the seller, will have time to catalogue the works properly, place them in the most appropriate sale, publicize the sale and pay the owner in a timely fashion after being paid by the buyer, which can frequently be as long as 30 to 45 days after an auction. Since valuation is not a precise science, fair market value, more often than not, can be a range of value determined by the circumstances of the presumed sale (e.g. estate or donation valuation), and the market in which the object is being offered for sale (e.g. auction or dealer market).
Appraisers using the comparative market data approach to structure value, and those who use comparable auction sales as the building blocks of this structure, should be very careful to make sure that the buyer’s premium is included in the auction comparable(s) used in the appraisal.
The interpretation of the nuances of fair market value has been the subject of much litigation in tax court and of lengthy judicial decisions. However, one can see from this brief summary that both the definition of fair market value and its application have very specific meanings for the IRS.
With this knowledge both the appraiser and the client should bear in mind that the term “fair market value,” is one that has been defined by the courts and the IRS; and that this type of valuation should only be used for appraisals which will be submitted to the IRS. Other types of appraisals require other types of value, which will be discussed in future columns.
The correct definition of value is just one of the many elements of a correctly prepared appraisal. For a complete list of the “Elements of a Correctly Prepared Appraisal”, please contact the Appraisers Association of America.
This article appeared in the Antiques and The Arts Weekly, November 17, 1995, page 28 and was written by Victor Wiener.