How to arrive at the fair market value of a property, and its importance in income tax laws

We look at the importance of fair market value under the tax laws and how one can arrive at or obtain the fair market value of a property

The concept of fair market value is very important under the income tax laws. The buyer, as well as the seller of a property will be impacted, if the sale/purchase consideration as stated in the agreement is lower than the fair market value of the property. In this context, we will discuss what fair market value is and how it impacts buyers and sellers.

Importance of fair market value under the income tax laws

Any profit on the sale of a property, is taxed under the income tax laws. The profit is generally arrived at, by deducting the cost of acquisition and cost of improvement, from the sale consideration. If the property is held for more than two years, you are allowed to avail of the benefit of indexation, on the costs. For properties that are acquired by you prior to April 1, 2001, you have the option to take the fair market value of the property as of April 1, 2001, in place of the cost of acquisition. So, the concept of fair market value is important for finding out the cost of acquisition, for capital gains purposes.

Likewise, if the price stated in the agreement is lower than the stamp duty valuation of the property, the stamp duty valuation of the property, which is a proxy for the fair market value, is taken as the sale consideration, instead of the value stated in the agreement. So, if the agreement value is lower than the fair market value, both, the buyer and the seller will be impacted.

The difference between the agreement value and the fair market value, if it is more than 5%, is taxed in the hands of the buyer, as well as the seller, under different provisions of the income tax laws. Hence, it is important to ascertain the fair market value, before executing the agreement, to avoid the payment on such difference.

How to find out the fair market value of a property

Ready reckoner or circle rates:

The income tax laws do not provide any guidelines on how the fair market value of a property has to be arrived at. However, there are certain ways through which you can make an estimation of the fair market value of the property which would, generally, be acceptable to the Income-Tax Department.

In order to avoid under-reporting of the consideration in sale agreements (which is done to avoid payment of appropriate stamp duty), states have introduced the system of predefined prices, depending on the area and nature of construction. This is done through stamp duty ready reckoner, or announcement of circle rates, etc., which are generally notified every year.

Circle rate is the value below which a property cannot be bought or sold in an area. At this point, note that circle rates vary from locality to locality. They are revised from time to time by the local authorities, to keep the value close to the existing market value of property in a particular area. Even if the seller plans to charge an amount that is lower than the per sq ft circle rate, you will have to pay stamp duty based on the prevalent circle rate. If the property is being sold at a higher rate than the circle rate, the stamp duty will be calculated, based on the transaction cost in this case.

So, you can find out the fair market value from the stamp duty ready reckoner of 2001, if the property was acquired prior to April 1, 2019. If you had received the property as a gift, or as an inheritance, or had constructed it during any year after April 1, 2001, then, you can take the ready reckoner value to find out the fair market value of the property.

However, it is not as easy to find out the fair market value of a property as it seems, because the real estate market is a very heterogeneous market, where the rates of properties can vary very much, even within the same area. It becomes more difficult, in case you have to find out the fair market value for properties as old as 2001.

Valuation report:

If the ready reckoner rate is not available for a particular year, you have another option. You can obtain a valuation report, from a valuer who is registered under the wealth tax rules and who is recognised for determining the fair market value for income tax purposes. The registered valuer follows a standard process for the purpose of arriving at the valuation and issues a detailed valuation report for the same. The fee that a registered valuer can charge, is already prescribed under the laws.

You can also obtain the services of a registered valuer, if you feel that the valuation as per the ready reckoner is on the higher side. This may happen due to the reason that the rates declared in the stamp duty ready reckoner are uniform for the same plot of land, without there being any reference to the conditions of the property and any legal dispute around the property at that point of time. The registered valuer inspects the property and based on his inspection and other relevant considerations and circumstances, gives the valuation report stating the fair market value of the property, along with the basis for arriving at the valuation.

Which method should you choose?

It is important to note that the rates stated in the stamp duty ready reckoner are not mandatory and are just guidelines. So, if you feel that the stamp duty and circle rates are higher by more than 105%, you should obtain a valuation report from a valuer, to substantiate your case at the time of making the deal, without having to wait for your case being selected for detailed scrutiny. The Income-Tax Department generally accepts the valuation report of the registered valuer. Out of both the methods available to you, the second method, of obtaining the valuation report from a registered valuer is advisable, to make the matter stronger and convincing.