Tax Reporting for Real Estate Transactions

The IRS defines fair market value (FMV) as the price at which a willing buyer and a willing seller would exchange a property, assuming neither party is under any compulsion to buy or sell and both have reasonable knowledge of relevant facts. It’s the standard of value for income tax purposes. FMV does not consider what the asset’s owner paid for it or how much they value it, but rather what others would be willing to pay for it. It’s the price that’s fair for both the buyer and the seller, and it is determined by what others believe the asset is worth in the market.

Fair value is based on an exit price, which is the 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. This is different from the transaction price or entry price, which is the price that was paid for the asset or received to assume the liability.

Fair value accounting doesn’t apply to entity-specific factors, such as transaction costs or buyer-specific synergies. It also doesn’t apply to relationships, such as business partnerships or relatives, as these relationships can affect the price. For example, if a company is being liquidated, its assets will not be sold at fair value.