Running a successful - and compliant - nonprofit organization demands a sound understanding of the concept of fair market value (FMV). The need to account for fair market value spans many aspects of nonprofit operations, such as accepting donations and issuing tax receipts, as well as ensuring that incurred expenses do not infringe upon private benefit and private inurement rules.
What is fair market value?
As defined by the IRS, FMV is “the price that property would sell for on the open market. It is the price that would be agreed on between a willing buyer and willing seller, with neither being required to act, and both having reasonable knowledge of the relevant facts.”
As related to nonprofit organizations, FMV simply ensures two things:
(1) that individuals and entities who contribute to a nonprofit organization receive a fair tax deduction
(2) that nonprofits (who have been granted the privilege of tax-exemption) spend their funds appropriately
How is the fair market value of something determined?
By and large, the FMV of any contribution is based on its selling price - value at the time of contribution. The original purchase price or cost of production does not affect the FMV of an item today.
More specifically, the following factors are considered in the determination of fair market value:
The cost or selling price of the item
Sales of comparable properties
Opinions of experts
For specifics on how each of these factors can be employed, check out the IRS website here: https://www.irs.gov/publications/p561.
When does FMV come into play?
When a nonprofit pays for goods, services, or employees
Determining FMV is rather simple for most goods and services purchased under normal circumstances. For example, a nonprofit purchasing milk can easily check with a local grocery store to determine that the price they are paying is the fair market value — what the market is willing to pay.
Or, take the example of paying an employee. Determining the FMV of someone’s labor (and thus ensuring your compensation is at or below FMV) is rather concrete — easily justified by their education level, skill set, location, and job responsibilities.
Say a nonprofit secured a $20,000 title sponsor for an event. That’s amazing! But how much of that contribution is actually tax-deductible? To determine the answer to this question, the nonprofit would need to understand fair market value. In the case of corporate sponsorships, unlike typical charitable contributions, benefits are often received in exchange for a donation. For example, the business may get tickets, signage, a booth where it can inform others about its products or services, an advertisement in a program or online recognition for their contribution. The fair market value of these benefits must be quantified and subtracted from the contribution amount in order to determine the amount of the donation that is actually tax-deductible.
Selling tickets for a fundraising event
Event tickets work pretty similarly to corporate sponsorships. When a nonprofit hosts a fundraising event, attendees may receive benefits while attending. For example, say a ticket to a fundraiser costs $300 but the attendee is served a formal dinner that costs $60.00. To determine the total amount of the ticket that is tax-deductible (truly a gift), the nonprofit must subtract the FMV of the dinner ($60) from the ticket price ($300). As a result, $240 of the $300 contribution would be considered tax-deductible.
An individual or company makes a noncash contribution to your nonprofit
Nonprofits often receive noncash charitable contributions. In these instances, determining the fair market value of the donation that is a physical asset is much more challenging than when cash is contributed. This is because in-kind donations often arrive in a variety of states and forms — having experienced appreciation, depreciation or changes in the market since the time of original purchase.
Check out the following examples for some clarification:
An individual purchases a computer for $900. A few years later, the computer still works but the owner wants a new one, so they donate the old one to a local nonprofit. What is the fair market value of that computer at the time of contribution? Certainly not the $900 that they purchased it for years ago since it's used and an older model. Rather, the FMV of this item would be what the computer would sell for on the market today.
Piece of artwork
An individual owns an Andy Warhol painting that their grandfather purchased for a few hundred dollars before Warhol was a famous artist. Now the painting is appraised at $10 million dollars. When the individual decides to donate the painting to LACMA, what is the fair market value? $10 million dollars.
Additional resources and specifics related to FMV are provided by the IRS here: https://www.irs.gov/publications/p561