The fair market value and the adjusted base value are calculations used at different times to determine an asset’s worth. Fair market value is a general calculation to determine the value of an asset if it were to be sold. People use this value as the basis for determining property taxes by the government.
Adjusted base value is a more complicated process that involves calculating the increase or depreciation of an asset due to different factors. When you sell your home or business, be sure you have a firm understanding of fair market value and adjusted base values before you start. Professional accountants and real estate attorneys can help determine the value of each and will guide you through the process of calculations.
Fair Market Value
The fair market value of a business or asset is the estimation of the price that would be paid to the owner upon a sale. The formula for determining fair market value includes business worth and assets in the current financial markets. Determining fair market value is tricky, simply because the only way to prove true value is to sell the business and assets.
Companies use balance sheets to determine current market value as an estimation. Included in these balance sheets are estimates of the expense of an asset over its lifetime. The calculation of capital improvements, depreciation, sales taxes, and marketing costs are referred to as adjusted base value.
When Is Fair Market Value Important?
Fair market value is used to assess property taxes. The government will assess the fair market value of your home or business to determine the taxes that you owe. This doesn’t always reflect the actual price of your asset; it is simply a representation of what the government believes your property to be worth. Insurance companies also base claim payouts on fair market value estimates.
When you want to sell your home or business, the realtor will perform calculations based on annual tax statements and compare other sales in the area to determine the fair market value. The adjusted base value will reflect the additions and damages to your home.
Adjusted Base Value
Adjusted base value describes the amount a taxpayer has invested in his or her assets. Expenses from acquiring or disposing of assets, acquisition, and selling costs fall under adjusted base value. It considers the assets of an owner beyond the purchase price.
For example, if your business purchases equipment that it projects will last for many years, the whole amount cannot be taken into consideration for the year’s business tax. The equipment will need to depreciate for tax purposes over the course of its lifetime. To determine the adjusted base value of a business, there are many factors to be considered:
- The asset’s cost
- Fair market value
- Exchanges or upgrades to assets
- Transferring or gifting assets to another taxpayer
When selling a home or business, the adjusted base value affects many things. If you have made major additions or improvements to the home or business, the adjusted basis will be a factor during a sale. The same is true for losses to the home or business. If a natural disaster causes you to incur expenses, it can reduce the profit from a sale. Adjusting the tax base because of improvements allows the taxpayer to deduct expenses when they sell a property.
Determining Fair Market Value and Adjusted Base Value
The process of determining fair market value and adjusted base value requires the expertise of professionals. Realtors and accountants can help determine the value of each for your home or business. The deductions and increases in value are calculated differently for different circumstances. The IRS considers gifts, acquisitions, and charitable sales all differently. Hiring a professional with experience in the area will ensure the legality of your business operations.
Example of Adjusted Base Value for Tax Purposes
You and your spouse bought a home for $300,000 and spent $30,000 in upgrades. The $30,000 upgrade is added to the tax basis, bringing the adjusted base value to $330,000. If you decide to sell your home for $400,000, the profit on your part would be $70,000 (not including realtor commission). The amount of time between original home purchase and home sale will also increase depreciation of the structure. Depreciation of the structure will be subtracted, changing the adjusted base value. This will increase the amount that you will be taxed when the property is sold. Land does not depreciate, so the fair market value of the land will remain the same.
Increases to basis can include:
- Building an addition to your home or business
- Roof replacement
- Paving or repaving driveways or parking lots
- Extension of utility lines to property
- Addition of roads or sidewalks
- Restoration to damaged property
- Zoning fees
- Abstract of title fees
- Legal fees
- Recording fees
- Owner’s title insurance
Decreases to basis can include:
- Casualty or theft losses
- Insurance reimbursements
- Residential or business energy credits
- Property structure depreciation
- Non-taxable corporate distributions
There are numerous factors that can determine adjusted base value changes in accordance with IRS regulations. Donations, gifts, changes from personal to business use, and hundreds of additional factors are handled differently. To properly calculate and consider each factor involved, hiring a professional is always recommended. Professional calculations will guarantee your values are accurate and will be reported to the IRS.
The Difference Between Fair Market Value and Adjusted Base Value
Fair market value is the estimation by the government or other entities used to determine the worth of your property. If you were to sell your home or business, the fair market value is an estimation of what would be paid for your property.
The adjusted base value is a figure calculated by determining how much value is added or subtracted to your property, in the form of improvements or depreciation. Each value is calculated and used at different times, for different reasons. The process is extremely complex and should be determined by professionals with experience in both calculations.