Concepts
Fair market value
Fair market value is the price that a willing buyer and a willing seller, dealing independently and with reasonable knowledge, would agree for an asset or service in an open market.
Fair market value is another way of describing the price an asset or service would reasonably be expected to achieve in an open market sale between informed parties acting independently. The word fair adds emphasis to the idea that the price should not be distorted by pressure, special relationships or unusual circumstances. In most practical tax discussions, it is used interchangeably with market value.
The concept is used whenever there is a need to put a dollar figure on something that has been transferred without a normal sale. Examples include a gift of property, a transfer of an asset between related parties, an asset that moves between a business and its owner, or the value of a benefit provided to an employee. Using fair market value helps ensure the tax outcome reflects the economic substance rather than an arbitrary price.
There are accepted ways to estimate it. For quoted securities, closing prices on an exchange provide a direct answer. For vehicles and equipment, dealer guides, auction results and comparable listings are useful. For land and buildings, an independent registered valuer is generally the best source, and the ATO recognises that valuations should be supported by reasoned analysis. For a business as a whole, valuation methods may consider earnings, assets and goodwill.
There are also situations in which the value is tested from different angles. When someone donates property, the deductibility rules for gifts may rely on the market value. For capital gains tax, market value substitution rules can apply when assets are acquired or disposed of in particular circumstances. In GST, the fair market value of goods or services can be relevant when supplies are made without consideration between associates, or when assets are applied to private use.
Because valuations can be questioned, it is wise to document the process. Keep the valuer's report, the date it was prepared, and any comparable sales or quotes. Where a valuation is for a specific tax purpose, ask for it to address that purpose, and make sure the valuer is independent and qualified. Valuations may also be needed at a particular date, such as when an asset is first used in the business or when ownership changes.
A common misunderstanding is believing that the book value shown in your accounts, or the amount you originally paid, is the fair market value. Neither is necessarily so, as market conditions change. Another is picking a convenient figure without any support. This can lead to disputes, adjustments and penalties if the figure is later found to be unreasonable. This is general information only, so confirm how fair market value applies to you with the ATO or a registered tax professional.
Worked example
Ravi gives a work trailer from his business to his adult son. The trailer cost $9,000 three years ago and its book value is $4,500, but similar trailers are being sold for about $6,000. The fair market value is therefore taken to be around $6,000, supported by three comparable online listings he saves. That figure, rather than the book value, is the starting point when working out any tax consequences.
Practical tips
- Support any valuation with evidence such as comparable sales, a dealer guide or an independent valuation report.
- Do not use book value or original cost as a substitute unless the rules specifically allow it.
- Ask whether the valuation needs to be at a specific date and prepare it for that date.