The Fair Market Value of property is the price that a willing buyer and willing seller will accept in a transaction. A willing buyer and a willing seller must neither be compelled to buy or sell the property (not a distressed transaction). If
Fair Market Value cannot be easily determined, it can be estimated using the trading prices of similar assets recently sold, various valuation techniques (cost method, income capitalization method), or the opinion of a professional appraiser.
The cost approach is a method
that is used to value real estate by estimating the
replacement cost of the structure. The underlying
rationale of the method is that nobody would pay
more for real estate than it would cost to buy raw
land and build the structure them self. For this
method to accurate, deterioration and the functional
obsolescence of existing buildings must be
estimated.
The income capitalization
approach is a method used to value real estate as an
investment. This method projects a return to the
investor’s capital based on the purchase price of
the real estate. Fair market value can be determined
if the investors return on the purchase price is
comparable to other investors’ returns on similar
investments with similar amounts of risk. Two ways
of performing the income capitalization approach are
by discounting future cash flows or by performing
what is called a “Direct Cap”.
The comparable sales method is
the easiest way to estimate fair market value. The
comparable sales method estimates the value of real
estate by comparing it to the sales prices of
similar property. The sales prices of comparable
properties are often broken down to a “per square
foot basis” and used to approximate the value of
similar property
Example: Richard is interested
in a 1031 Tax Exchange but first wants to know what
his rental property is worth. Richard's rental
property is a 3-Bedroom 1,400 square foot home in
Nashville Tennessee. The house down the street
recently sold for $250,000 and was a 3-bedroom
1,500 square foot home ($167/square foot). Richard
also knows that the 3-Bedroom, 1,250 square foot
home around the corner recently sold for $218,750
($175/square foot). Using the comparable sales
approach, Richard can estimate that his home is
worth between $167-$175/per square foot or between
$233,333-$245,000.
Realized gain or loss:
The realized gain or loss on a transaction is the difference between the amount realized from the disposition of the property and the taxpayer’s adjusted basis in the property. |
