According to IRS Publication 561, fair market value (FMV) is the price that property would sell for on the open market. It is the price agreed upon between a willing buyer and a willing seller, with neither required to act and both having reasonable knowledge of the relevant facts. This definition is the standard the IRS uses to determine if an item sold or donated by you is appropriately valued for income tax purposes. It’s also a definition that’s open to interpretation. If the IRS decides your FMV opinion is incorrect, you’re not only subject to more taxes but also penalties to boot. Here are some tips to help defend your FMV in case of an audit.

Understanding fair market value

FMV is used whenever an item is bought, sold, or donated, as these transactions have tax implications. Some of the more common examples include:

• Buying or selling your home or other real estate
• Buying or selling personal property
• Buying or selling business property
• Establishing the values of other business assets, like inventory
• Valuing charitable donations of personal goods and property, like automobiles
• Valuing the barter of services
• Valuing transfers of business ownership
• Valuing the assets in the estate of a deceased taxpayer

Defending your FMV determination

To help defend your FMV determinations, consider the following:

Properly document donations. The FMV of non-cash charitable donations is an area that the IRS can easily challenge. Ensure your donated items are in good or better condition. Properly document the items donated and keep copies of published valuations from charities like Goodwill. 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 receiving the automobile will use it themselves or provide it to someone who will. If not, the charity’s resale value will determine the FMV of the donated vehicle. Therefore, exercise caution when contributing to organizations such as Kars4Kids, as they may restrict the value of your donation!

Get an appraisal. If you sell a small business, a collection, artwork, or a capital asset, consider obtaining an independent appraisal of the property beforehand. While still open to interpretation by the IRS, getting a third-party appraisal can be a solid basis for defending any differences between your valuation and that of the IRS.

Keep copies of similar items and 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 sold, it can readily support your FMV claim.

Take photos. The condition of an item is often a key determinant in establishing FMV. It is fair to assume an item has wear and tear when you sell or donate it. You can use visual documentation to support your claimed amount.

Keep good records. Keep copies of invoices for major purchases and retain bills for any improvements. Make sure your sale of property includes a dated bill of sale that clearly states the transfer of ownership and the amount paid for the item.

With proper planning, establishing the fair market value can be done in a way that is defensible against a challenge from the IRS. Contact our RRBB advisors if you have any questions.