There are almost 250 sections of the Internal Revenue Code require stating something known as Fair Market Value (FMV) in order to determine tax liability. In the auction world, FMV may be used to illuminate auction estimates for everything from Picassos to pearls. The nuances of determining Fair Market Value however, continue to cause confusion for collectors, tax court judges and even some appraisers.
Fair Market Value is a complex determination of value defined by the U.S. Federal government for tax liability assessment, be it estate tax, gift tax or income tax. The “good book” when it comes to FMV is regulation Sec.20.2031-1(b). Many appraisers and estate attorneys can recite by memory the first part of this regulation:
However, failure to consider the regulation in its entirety may lead to inaccurate valuations. The regulation states that that FMV is not to be determined by a forced sale price. So, while the government considers the sales price of tangible estate assets to be the most probative evidence of its Fair Market Value, the relevant regulation recognizes the owner’s right not to sell, due to the benefits attendant to retained ownership. Fair Market Value, therefore, can describe the value of property unsold. Without an actual sale price determining FMV, appraisers typically rely on the Market Comparison Approach to arrive at values.
This appraisal method entails determining FMV of an object by relating it to the past sale results of items with similar qualities. These “comparables” must share something in common with the subject property, such as maker, size, age, material and condition. However, handmade objects like paintings and fine antiques can make finding diagnostic comparables difficult and subjective, due to the unique nature of such objects. Other factors, such as provenance and vendor status are equally unscientific, yet can also impact value.
The sale of such qualitative comparables must also have occurred in a relevant marketplace, that is, where such property is generally obtained by the public in a retail market. Determining the appropriate marketplace occurs on a case-by-case basis, as no single marketplace necessarily qualifies a priori. What a jewelry dealer pays for a diamond from an importer could not be taken as the Fair Market Value of the same stone after it has retailed to the general public.
Finally, the market comparison approach is predicated upon sales of comparables within a reasonable length of time prior to the appraisal date. Stale results, too old to illuminate the current market, may not be relevant, nor is anticipation of future value typically allowed, as such predictions are inherently unknowable and unreliable.
The Appraisal Foundation, a not-for-profit organization authorized by Congress, was created in 1987 to support the appraisal profession by creating method standards and codes of ethics. These are codified and published in the Uniform Standards of Professional Appraisal Practice (USPAP). All the major Appraisal organizations, such as the Appraisal Association of America (AAA) and the International Society of Appraisers (ISA), require adhering to USPAP a requirement for membership.
Critical to the understanding of Fair Market Value is its inherent subjectivity, which even the Appraisal Foundation acknowledges. According to the USPAP, “Value expresses an economic concept. As such, it is never a fact, but always and opinion of the worth of a property at a given time in accordance with a specific definition of value.”
Following the complete definition of FMV defined by the Treasury Department and the tenets of USPAP helps keep this problematic process of determining Fair Market Value manageable.