You could be trying to buy your very first home or you could be the owner of a lucrative piece of real estate trying to sell it. In both cases, it is very important to determine the fair market value of your property. The correct calculation ofÂ the fair market value of a property and its usage in key legal and financial settings brings out its importance.
Primarily, fair market value is used in real estate for the correct valuation of a property. However, there are many instances whereÂ the fair market value of a property is commonly referred to or used. Some of these are:
- Sale and purchase
- Insurance claims
- Stamp duty collection
- Portfolio management
- Legal issues like divorce, bankruptcy, etc.
You donâ€™t want to be overcharged while buying a property. Similarly, you would not want under profit from the sale of real estate, also, when real estate is not correctly valued, bank loans could be difficult to get or not be of the right amount. Hence, the determination of the correct fair market value of your property is fairly important.
Importance in Income Tax
The fair market value of your property helps you to be tax compliant. Property sales provide you with capital gains, one of the reasons why real estate is considered a lucrative investment proposition. The difference between the fair market value and the sale price is the profit on which tax in the form of Capital Gains Tax is levied. So, any inaccuracy in the fair market value of a property could lead to alerts from the Income Tax department.
Not only the seller but the buyer too is impacted if the agreed purchase value is lower than the fair market value of the property. According to income tax laws, when the difference between the sale/purchase value and the fair market value is upward of 5%, it is taxed to both the buyer and the seller. Therefore, it is important to find out the correct fair market value, before executing any sale/purchase agreement to avoid undue tax penalties.
Following the 2017 budget, theÂ base year for the calculation of theÂ fair market value of a property has been changed from 1981 to April 1, 2001. This translates to significant tax savings for properties purchased before April 2001. Thus, the fair market value of a property can impact tax liability significantly.
Accurate fair market value is vital towards determining the cost of acquisition for capital gains purposes. Moreover, for properties that are with you for more than two years, one can avail of the benefit of indexation on the costs.
Calculating Fair Market Value of a Property
There are a variety of methods to ensure an accurate fair market value of your property. The first point of reference is the Circle Rate. These minimum rates of properties, periodically revised, for particular areas are fixed by relevant authorities at the local or state government level. However, circle rates and the market rates of real estate have huge gaps. Therefore, circle rates are at best a reference point for stamp duty and registration charges if nothing else.
Second, a market analysis of prices in the locality is a good indicator of ascertaining the fair market value of your property. Real estate agents, forums and websites are a good point of reference.
Third, property index lists give a fair idea about property prices over a period of time. While indices like Residex, Housing Price Index (HPI), Residential Property Price Index (RPPI), etc. provide pricing trends, they have their own drawbacks. They cover only first-tier cities and do not always have recent data.
All the above reference points are in combination a good point for arriving at the neighbourhood of the fair market value of a property. Finally, registered property valuers who are government-approved professionals can make the task easier and more accurate for you with their valuation reports based on standard procedures.
Factors Affecting Fair Market Value of a Property
Fair market value is the price that you would sell your property for on the open market.Â TheÂ fair market value is significant to those who own a property or looking to sell it and have to pay taxes on it. Thus, a property-based deduction will require determining the fair market value which is in the true sense of the term â€˜fairâ€™. If you are an avid real estate investor you should know these variables which affect the fair market value:
- Property type such as plot, independent house, builder flats, etc.
- Demand and supply based on economic conditions.
Understand the vital role thatÂ the fair market value of a property plays and grow your wealth reliably through real estate.