Understand what fair market value is and how to calculate it. Fair market value is an essential notion in Indian income tax law. If the sale/purchase consideration indicated in the agreement is less than the property’s fair market value. Both the buyer and seller would be impacted. In this context, we’ll talk about what fair market value is and how it affects buyers and sellers.
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What is the fair market value?
Fair market value is the amount that a seller is ready to pay for an object at a given time based on its worth. The Indian Accounting Standard (AS) 113[1] defines fair market value as the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date. Fair market value refers to:
- The sale of an asset
- The transfer of liabilities
- This is not a forced or distressed sale.
- It is clearly market-based, not entity-based.
- It is reached at when the sale or transfer occurs.
Factors that Influence the Fair Market Value of Property
The fair value of a property might rise or fall depending on the following factors.
Locality
Location is a key factor in determining a property’s value. Property values in cities such as Mumbai, Delhi, Bangalore, and Chennai range significantly between rich and developing neighbourhoods. For example, a home in Malabar Hills, Bandra, or Juhu may cost multiple crores, whereas a similar property in a developing region may be less expensive, priced at Rs 50 lakh.
The exact location within a locality
Even within a desirable neighbourhood, the particular placement of a house is important. Future development & appreciation rates may be influenced by factors such as corner site placement or proximity to a main road.
Amenities
The facilities and features that come with a home often improve its value. Features like a private swimming pool, lifts, and neighbouring business establishments are perceived more positively post-pandemic. Which might lead to increased appreciation.
Infrastructure
Properties that benefit from infrastructural enhancements tend to appreciate more. Land prices in Ayodhya, for example, have risen significantly after the inauguration of a big temple, as have those near the Jewar Airport in Greater Noida. The Mumbai Trans Harbour Link (MTHL), which opened earlier this year, has a favourable impact on real estate prices in both Navi Mumbai & Mumbai, thanks to the connection it provides. Additionally, costs in and around the Navi Mumbai Airport have increased.
Demand and Supply
The balance of demand & supply is a significant factor in property appreciation. A house with great attributes may not appreciate considerably if there is a low demand or an oversupply of comparable properties.
Interest Rates
The interest rates paid by borrowers directly affect the increase in property values. Elevated interest rates have the potential to dampen buyer fervor and restrict the growth potential of a property’s worth.
Time
Real estate investments typically provide long-term profits. A property’s value is more likely to improve over time than it is to fluctuate in the short term.
Property buyers & investors must consider these elements in order to make informed judgements and appreciate the real estate market’s potential for appreciation.
Comparing a property’s fair market value to its market value
While the phrases fair market value & market value are sometimes used interchangeably, they have different meanings despite their similarities.
| Parameters | Fair market value | Market value |
| Definition | FMV is defined as the amount that a willing buyer & a willing seller, who are not required to buy or sell and who both have reasonable knowledge of the pertinent facts, would exchange for a piece of property. | Market value is the property’s current open-market worth when supply, demand, and the state of the economy are taken into consideration. In a normal, competitive real estate market. It is the price that a buyer is willing to pay or a seller is willing to accept. |
| Considerations | FMV addresses the hypothetical scenario of a fair & open market transaction in which both parties act in their own best interests. | The real estate market’s actual situation at the moment, taking into account previous sales. Similar properties, and regional economic circumstances, is the main focus of market value. |
| Use and implications | FMV is commonly employed in legal and fiscal applications, such as estimating property taxes, calculating capital gains taxes, and appraising asset value in estate planning. | Market value is frequently utilised in real estate transactions to calculate a property’s asking price or offer amount. Real estate professionals generally utilise recent comparable transactions to determine market value. |
Methods to Determine Fair Market Value
- The selling price of a recent property might assist assess its fair market worth.
- By contrasting it with a comparable property, you can determine the fair market value.
- Comparing the property prices of similar configurations in that area and community can assist evaluate the fair market value.
- Hiring professional assistance may help you achieve the proper market value.
The significance of fair market value under the income tax legislation
Fair market value under income tax.
Section 2(22B) of the Income Tax Act defines the capital gains price for a certain time as the fair market value.
Any profit earned from the sale of a property is subject to income tax. Profit is normally calculated by deducting the cost of acquisition and improvement from the sale consideration. If you have owned the property for more than two years, you are eligible for cost indexation. For properties acquired before to April 1, 2001, you may use the fair market value of the property as of April 1, 2001, instead of the cost of acquisition. So, the concept of fair market value is critical for determining the cost of acquisition for capital gains purposes.
Similarly, if the price mentioned in the agreement is less than the stamp duty valuation of the property, the stamp duty valuation. Which is a proxy for fair market value, is used as the selling consideration rather than the value stated in the agreement. So, if the agreement value is less than the fair market value, both the buyer & the seller will be affected.
If the difference between the agreement value & the fair market value exceeds 5%, both the buyer and the seller are subject to income tax under various conditions. As a result, it is critical to determine the fair market value before entering into the agreement in order to prevent paying for such a disparity.
How To determine the fair market value of a property?
Ready reckoner or circular rates.
There are no rules for figuring out a property’s fair market value in the income tax legislation. Nonetheless, there are particular techniques that are typically accepted by the Income-Tax Department for determining the property’s fair market value.
To prevent under-reporting of the consideration in sale agreements (which is done to avoid paying the required stamp duty), states have implemented a system of predefined values based on the area and nature of construction. This is accomplished by the use of a stamp duty ready reckoner or the declaration of circle rates, which are typically notified once a year.
Circle rate
The circle rate is the minimum price at which a property in a given area cannot be purchased or sold. It is important to remember here that circle rates differ by location. They are periodically amended by local governments to keep the value similar to the current market value of property in a given location. You have to pay stamp duty based on the current circle rate even if the seller plans to charge less than the per square foot circle rate. Stamp duty will be applied based on the transaction cost in the event that the property is sold for more than the circular rate.
So, if the property was acquired before April 1, 2019, you can calculate the fair market value using the stamp duty quick reckoner from 2001. If you obtained the property as a gift or inheritance, or if you built it after April 1, 2001, you can use the ready reckoner value to determine the property’s fair market value.
However, because the real estate market is so varied and prices can vary significantly even within the same location. Figuring out a property’s fair market value is not as easy as it might seem. Determining the fair market value of homes that were built before 2001 becomes more difficult.
Valuation Report
If the ready reckoner rate is not available for a specific year, you have alternative choice. You can get a valuation report from a valuer who is registered under the wealth tax laws and is qualified to determine fair market value for income tax reasons. The registered valuer follows a prescribed process to arrive at the valuation and then issues a complete valuation report. The fee that a registered valuer can charge is already specified in the laws.
If you believe the valuation provided by the ready reckoner is too high, you might hire the services of a registered valuer. This could happen because the rates declared in the stamp duty ready reckoner are consistent for the same piece of land. With no regard for the property’s conditions or any legal disputes surrounding the property at the time. The registered valuer inspects the property and, based on his inspection & other relevant considerations & circumstances, issues a valuation report detailing the property’s fair market value, as well as the basis for the appraisal.
Which method should you use?
It is crucial to note that the stamp duty ready reckoner rates are not mandated but rather serve as guides. So, if you believe that the stamp duty/circle rates are more than 105% higher. You should get a valuation report from a valuer to support your case at the time of closing the deal. Rather than waiting for your case to be picked for detailed review. The income-tax department normally accepts the registered valuer’s valuation report. The second approach open to you, acquiring a valuation report from a registered valuer, is recommended to make the case stronger and more believable.
Challenges of determining the fair market value of property
There is no general formula that applies to all cases, making it difficult to determine fair market value. This is not a “one-size-fits-all” circumstance. The accuracy of calculating fair market value is greatly dependent on the appraiser’s competence and the facts at their disposal. Fair market value, unlike a fixed assessment, is more of an estimate because it is dependent on a variety of circumstances.
Unique commodities, such as art or handmade goods, are especially difficult to value in the market. The lack of comparable things makes it difficult to determine a standard value. Assessing fair market value is essentially an art rather than a science, & its precision is determined by the appraiser’s skill and knowledge, as well as the available data.
Conclusion
The process of determining a property’s fair market value is multidimensional and takes into account a variety of elements. Adhering to legal rules, using professional valuation services. And being educated about market trends are all critical components of a fair and effective property sale. Finding the right value allows sellers to locate buyers far faster than sellers who rely on guesswork & wishful thinking when valuing their property. Using professional guidance can help owners determine the actual fair worth of their property and rate it appropriately.
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