Determination of Fair Market Value
The Fair Market Value of an investment has been broadly defined by the Court as:
“The price at which property would change hands between a hypothetical willing buyer and a hypothetical willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts.”
U.S. v. Cartwright, 411 US 546 (1973).” This is understandably relatively vague for most people. There is a set of case-law that helps appraisers have some bounds around what is acceptable when determining the value of many assets. This same case-law can be extrapolated out to determine the fair market value of other assets in similar situations.
Discounts to Fair Market Valuations
Most private investments do not have a readily available exchange to sell in. In many situations, there are significant constraints to be able to sell an asset. Some investments have clauses in their contracts that state that the investment is not transferable. Some have no liquidity opportunities, long durations to a liquidity event, uncertain futures. They might be non-performing at the moment. Buyers may not be available, the list goes on. The IRS understands this, and flexibility is afforded to adjust the value of the investment based on market conditions. People are not required to “window dress” or spend time and money marketing their assets for sale, then use that condition of the asset for the basis of what they could sell it for. The hypothetical sale of the asset should be based on “as-is” condition. This means, for example, a rental house does not need to be painted or the lawn mowed. Sure, the property might have a higher resale value if there is a quality long-term renter in place. But, this is not the expectation when determining the value of the property. In fact, the best time to have the property valued is when it is in it’s messiest state. A good time to have your rental property valued would be after you have done some demolition and you haven’t yet removed the debris. You may not have the occupancy permit yet from the county, great! Who would want to buy that? A lot fewer people. The fact that there could be flippers out there who could visualize the potential value and would be happy to take it off your hands doesn’t matter. This, again, isn’t the expectation when determining the property’s fair market value.