What is fair market value of property? How to calculate it?

Know the importance of fair market value and to arrive at this value.

The concept of fair market value is quite important under the income tax law in India. The buyer as well as the seller of a property will be impacted if the sale/purchase consideration as stated in the agreement is lower than the fair market value of the property. In this context, we will discuss what fair market value is and how it impacts buyers and sellers.

 

What is fair market value?

Fair market value can be described as the price of an asset that a seller will be willing to pay at that given point of time based on the worth of the asset. According to The Indian Accounting Standard (AS) 113[1], fair market value is price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair market value refers to: 

  • The selling of an asset
  • The transfer of liability
  • It is not a forced or distressed sale
  • It is clear it is market-based not entity based
  • It is arrived at when the sale or transfer takes place 

Factors that influence fair market value of property

The fair value of a property can either appreciate or dip based on the following factors:

Locality

The location is a crucial factor influencing a property’s value. In cities like Mumbai, Delhi, Bangalore and Chennai, the difference in property values between affluent and developing areas is significant. For instance, a property in Malabar Hills, Bandra or Juhu may cost multiple crores, while a similar property in a developing area could be more affordable, priced at Rs 50 lakh.

Exact location within a locality

Even within a great locality, the specific location of a property matters. Factors like being a corner plot or proximity to the main road can influence future growth and appreciation rates.

Amenities

The amenities and facilities associated with a property contribute significantly to its value. Features such as a private swimming pool, elevators, and nearby commercial establishments are viewed more positively post-pandemic and can lead to greater appreciation.

Infrastructure

Properties benefiting from infrastructure updates tend to appreciate more. For example, land rates in Ayodhya, following the inauguration of a grand temple, and areas near the Jewar Airport in Greater Noida have shown substantial growth.

Demand and supply

The balance between demand and supply is a key metric affecting property appreciation. A property with excellent features may not see significant appreciation if there’s muted demand or an oversupply of similar homes.

Interest rates

The interest rates paid by borrowers to acquire property directly impact its price growth. High interest rates can adversely affect buyer sentiment and limit a property’s potential for value appreciation.

Time

Real estate investments generally yield profits in the long term. The value of a property is more likely to increase over an extended period compared to short-term fluctuations.

Considering these factors is crucial for property buyers and investors to make informed decisions and understand the potential for appreciation in the real estate market.

 

Fair market value vs market value of property 

While fair market value and market value are terms often used interchangeably, they have distinct meanings despite certain similarities.

Parameters Fair market value Market value
Definition FMV is the price at which a property would change hands between a willing buyer and a willing seller when both have reasonable knowledge of the relevant facts, and neither is under any compulsion to buy or sell. Market value is the current value of a property in the open market, considering factors like supply, demand, and prevailing economic conditions. It’s the amount a buyer is willing to pay and a seller is willing to accept in a normal and competitive real estate market.

 

Considerations FMV considers the hypothetical scenario of a fair and open market transaction where both parties are acting in their best interests. Market value is more focused on the practical, current state of the real estate market, taking into account recent sales, comparable properties, and local economic conditions.
Use and implications FMV is often used in legal and tax contexts, such as for determining property taxes, calculating capital gains taxes, or assessing the value of assets in estate planning. Market value is often used in real estate transactions to determine a property’s listing price or offer amount. Real estate professionals typically use recent comparable sales to assess market value.

 

Methods to determine fair market value

  • Selling price of a recent property can help determine the fair market value.
  • By actually using a similar property as the benchmark, you can determine the fair market value.
  • By comparing the property prices of similar configurations in that locality and neighbourhood can help determine the fair market value.
  • Hiring professional help may help you reach the fair market value.

Importance of fair market value under the income tax laws

Fair market value under Income Tax

According to Section 2(22B) of the Income Tax Act, the capital gains price for a relevant period is the fair market value.

Any profit on the sale of a property is taxed under the income tax laws. The profit is generally arrived at by deducting the cost of acquisition and cost of improvement, from the sale consideration. If the property is held for more than two years, you are allowed to avail of the benefit of indexation, on the costs. For properties that are acquired by you prior to April 1, 2001, you have the option to take the fair market value of the property as of April 1, 2001, in place of the cost of acquisition. So, the concept of fair market value is important for finding out the cost of acquisition, for capital gains purposes.

Likewise, if the price stated in the agreement is lower than the stamp duty valuation of the property, the stamp duty valuation of the property, which is a proxy for the fair market value, is taken as the sale consideration, instead of the value stated in the agreement. So, if the agreement value is lower than the fair market value, both, the buyer and the seller will be impacted.

The difference between the agreement value and the fair market value, if it is more than 5%, is taxed in the hands of the buyer, as well as the seller, under different provisions of the income tax laws. Hence, it is important to ascertain the fair market value, before executing the agreement, to avoid the payment on such difference.

See also: All about sale deed and agreement to sale

How to find out the fair market value of a property?

Ready reckoner or circle rates

The income tax laws do not provide any guidelines on how the fair market value of a property has to be arrived at. However, there are certain ways through which you can make an estimation of the fair market value of the property which would, generally, be acceptable to the Income-Tax Department.

In order to avoid under-reporting of the consideration in sale agreements (which is done to avoid payment of appropriate stamp duty),  states have introduced the system of predefined prices, depending on the area and nature of construction. This is done through stamp duty ready reckoner, or announcement of circle rates, etc., which are generally notified every year.

Circle rate is the value below which a property cannot be bought or sold in an area. At this point, note that circle rates vary from locality to locality. They are revised from time to time by the local authorities, to keep the value close to the existing market value of property in a particular area. Even if the seller plans to charge an amount that is lower than the per sq ft circle rate, you will have to pay stamp duty based on the prevalent circle rate. If the property is being sold at a higher rate than the circle rate, the stamp duty will be calculated, based on the transaction cost in this case.

So, you can find out the fair market value from the stamp duty ready reckoner of 2001, if the property was acquired prior to April 1, 2019. If you had received the property as a gift, or as an inheritance, or had constructed it during any year after April 1, 2001, then, you can take the ready reckoner value to find out the fair market value of the property.

However, it is not as easy to find out the fair market value of a property as it seems, because the real estate market is a very heterogeneous market, where the rates of properties can vary very much, even within the same area. It becomes more difficult, in case you have to find out the fair market value for properties as old as 2001.

See also: All about ancestral property

 

Valuation report

If the ready reckoner rate is not available for a particular year, you have another option. You can obtain a valuation report, from a valuer who is registered under the wealth tax rules and who is recognised for determining the fair market value for income tax purposes. The registered valuer follows a standard process for the purpose of arriving at the valuation and issues a detailed valuation report for the same. The fee that a registered valuer can charge, is already prescribed under the laws.

You can also obtain the services of a registered valuer, if you feel that the valuation as per the ready reckoner is on the higher side. This may happen due to the reason that the rates declared in the stamp duty ready reckoner are uniform for the same plot of land, without there being any reference to the conditions of the property and any legal dispute around the property at that point of time. The registered valuer inspects the property and based on his inspection and other relevant considerations and circumstances, gives the valuation report stating the fair market value of the property, along with the basis for arriving at the valuation.

Which method should you choose?

It is important to note that the rates stated in the stamp duty ready reckoner are not mandatory and are just guidelines. So, if you feel that the stamp duty/ circle rates are higher by more than 105%, you should obtain a valuation report from a valuer, to substantiate your case at the time of making the deal, without having to wait for your case being selected for detailed scrutiny. The Income-Tax Department generally accepts the valuation report of the registered valuer. Out of both the methods available to you, the second method, of obtaining the valuation report from a registered valuer is advisable, to make the matter stronger and convincing.

 

Challenges of assessing fair market value of property

Arriving at the fair market value poses a significant challenge as there’s no universal formula applicable to all situations. This isn’t a one-size-fits-all scenario. The accuracy of determining the fair market value relies heavily on the appraiser’s expertise and the information at their disposal. Unlike a fixed valuation, fair market value is more of an estimation due to its dependence on numerous factors.

For instance, when it comes to unique items like art or handmade goods, pinpointing their market value is particularly tricky. The scarcity of comparable items makes it challenging to establish a standard value. Essentially, assessing fair market value involves more of an art than a science, and its precision is contingent upon the skill and knowledge of the appraiser along with the available data.

 

Conclusion

Determining the fair market value of a property is a multifaceted process that involves considering various factors. Adhering to legal guidelines, leveraging professional valuation services and staying informed about market dynamics are crucial elements for a fair and successful property transaction. Arriving at the right value helps sellers find buyers a lot quicker than sellers who rely on guesswork and wishful thinking when it comes to valuation of their property. Using professional assistance can help owners know the exact fair value of the property can rate it accordingly.

FAQs

How can you calculate Fair Market Value?

By using methods like a property’s selling price, comparing price with other assets, hiring professional help etc.

Cite some examples where Fair Market Value calculation is used.

Fair Market Value is calculated in share market, gifts, property taxes etc.

What is the difference between fair value and market value?

While market value depends on the market behaviour, fair value is a price that is agreed by a seller and a buyer.

What is market value of property?

The market value is the price at which a property can be sold. So, at a particular time, this is the fair price that the property commands.

Is fair market value recorded?

All assets that are sold or bought at fair market value should be recorded by accountants.

How to find fair market value of property?

You can assess the fair market value of property on the basis of circle rate or RR rate.

What is fair market value?

Fair market value is important for finding out the cost of acquisition, for capital gains purposes.

 

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