In the thousands of pages of U.S. Tax Code, there is a collection of terms used by the IRS that is unique to federal income taxes. One of the more important to understand is the phrase: Fair Market Value or FMV.
“Fair market value (FMV) is the price that property would sell for on the open market. It is the price that would be agreed on between a willing buyer and a willing seller, with neither being required to act, and both having reasonable knowledge of the relevant facts.”
Source: IRS Publication 561
This is the standard the IRS uses to determine if an item sold or donated by you is valued correctly for income tax purposes.
When is it Used?
FMV is used whenever an item that is bought, sold, exchanged, or donated has tax consequences. The most common examples are:
|Buying or selling your home or other real estate|
|Buying or selling personal property|
|Buying or selling business property|
|Establishing values of other business assets like inventory|
|Valuing donations of personal goods and property like automobiles|
|Valuing bartered services|
|Valuing transfer of business ownership|
|Valuing the assets in an estate of a deceased taxpayer|
Sound simple? As you can imagine FMV can be open to wide interpretation and disagreements with the IRS that have led to some very high-profile tax cases. For instance, the IRS believes the FMV of the estate of pop icon Michael Jackson is over $900 million while the representatives of the estate think its FMV is $7 million. This difference could lead to additional taxes and penalties of over $700 million!
What you need to know
While you don’t probably own anything close to the value of Michael Jackson’s estate, properly documenting FMV can help you defend against any potential IRS challenges. Here are some suggestions to help you defend your FMV determinations.
|Properly document donations. Charitable donations of non-cash items are a big area that FMV is challenged by the IRS. Ensure your donated items are in good or better condition. Properly document the items donated and keep copies of published valuations from charities like the Salvation Army. Don’t forget to ask for a receipt (confirmation) of your donations.|
|Donate capital items like automobiles to the correct places. You may use the FMV of a donated automobile but only if the charity you donate the item to will use it themselves, or will provide it to someone who will use it. Websites like Kelley Blue Book (kbb.com) can help establish the value of your vehicle when you donate it. Otherwise, the FMV of the donated vehicle will be limited to the amount the charity receives when they re-sell it.|
|Get an appraisal. If you sell a small business, collection, art, or capital asset make sure you have an independent appraisal of the property prior to selling it. While still open to interpretation by the IRS, this appraisal can be a solid basis for defending any differences between your valuation and the IRS.|
|Keep copies of similar item transactions. This is especially important if you barter goods and services. If you have a copy of an advertisement for a similar item to the one you bartered or sold, it can readily support your FMV claim.|
|Take photos. The condition of an item is often a key determinate in establishing FMV. It is fair to assume an item has wear and tear when you sell or donate it. Visual documentation can be used to support your claimed amount.|
|Keep good records. Keep copies of invoices for major purchases. Retain bills for any improvements. Make sure your sale of property includes a dated bill of sale that clearly states transfer of ownership and amount paid for the item.|
With proper planning, establishing the fair market value of an item sold or donated can be done in a reasonably defendable way.