What is Fair Market Value (FMV) and its tax implications for small businesses

What is fair market value (FMV)?

FMV is the highest price that a piece of property would bring in an open, unrestricted market between a fully informed and independent buyer and seller.

Typically, FMV applies only when you are transferring ownership of capital property—for example, a vehicle, a manufacturing facility, or even office furniture or computers. Consumable items, like stationery or pens, are not eligible for FMV transfer.

How can I determine fair market value?

If you want to transfer a personal asset to your business for FMV, the first step is to decide the fair market value for tax purposes. Assigning a fair market value for tax purposes is a specific process where you determine how much the item is worth in the open market.

There are different rules depending on whether your business is a sole proprietorship, a corporation, or a partnership.

FMW for sole proprietorships

For sole proprietors, let’s say you bought a computer several years ago for $1,500. You used this computer for your personal use for a number of years, and then you started your small business. The value of the computer has declined over those years. So to find the FMV, you’ll need to find out how much that computer would sell for today. A good place to start is by looking through classified ads for similar computers.

Suppose you determine that the computer is worth $500 today; that is the FMV. When you transfer the asset to the business, you would value the computer at $500. You can make these transfers at any time, and you can transfer as many personal items as necessary to run your business.

At tax time, you’ll use the $500 when calculating the capital cost allowance (CCA) on your tax return, which allows you to claim a portion of the value of the computer each year as a deduction, reducing your taxable income and, subsequently, your income tax burden.

FMV for corporations and partnerships

The rules for determining FMV are different for corporations and partnerships and involve an “elected” amount. The elected amount is the value that you (the seller) and the corporation (the buyer) agreed on and might differ from the item’s FMV. You’ll also need to make sure that the transfers meet specific criteria. If you’re unsure, it might help to speak with a tax professional.

Tax benefits of transferring personal assets

The main reason to transfer your personal assets to your business is to claim capital cost allowance (CCA) on your tax return. Claiming CCA allows you to deduct a portion (or in some cases all) of the value of the item from your income as depreciation, which in turn lowers your taxable income. The amount you can deduct for each asset per year depends on its CCA class. For example, if a transferred property belongs in class 1, you may deduct up to 4% of the property value annually.

What is book value vs. fair market value?

It’s important to note that FMV is not the same as book value. FMV estimates what your asset is worth today on the open market. This means an asset’s FMV is subject to market fluctuations.

On the other hand, book value is an asset’s original cost, plus any possible improvement costs, minus the depreciation over time. Book value is used to value assets on a balance sheet, whereas FMV is used to determine the value of an asset at the time of transfer.

Does fair market value include sales tax?

When you transfer personal property to your business, you may be able to claim the sales tax as an input tax credit (ITC) based on the FMV of the property.

But in order to claim the ITC, you’ll need to be a current or new registrant for the goods and services tax/harmonized sales tax (GST/HST). For instance, you may be able to claim the ITC for the GST/HST paid or payable on capital property or stock inventory.

Using the computer example above: for an Ontario business purchasing a computer for $500, the sales tax would be 13%. So the calculation would be:

$500 x 0.13 = $65

You can claim $65 as an input tax credit when filing your GST/HST return. This applies to businesses that are sole proprietorships, partnerships, or corporations. However, you may need to use the elected value to make this calculation if you are transferring an asset to your corporation.

How can I transfer my personal assets to my business?

You can transfer your personal assets to your company in a few ways. In some cases (for example, transferring your personal computer to your sole proprietorship), no actual money will change hands. You’ll transfer the asset as a new acquisition, noting the date and the transfer and using the FMV for your business records. (Your tax expert can help with this.) You’ll use the FMV to calculate the correct capital cost allowance (CCA) based on the class for the asset so you can deduct the depreciation at tax time.

Sometimes, though, you’ll want to go through the process of selling personal assets to your business. For example, through a direct sale. This process is more common when transferring from a sole proprietor to a corporation, as both companies will need to log the asset transfer as a new acquisition in their accounting records, and, in some cases, pay capital gains. This is different than simply buying new equipment outright in that only the buying company will need to log the acquisition and capital gains won’t apply.

For the individual or company that originally owned the item being transferred, you may need to pay capital gains if the asset gained value between when you made the purchase and when you transferred or sold the asset. Here’s an example of a transfer of property: Say you transferred a plot of land with a building where you store materials to your new business. You originally bought it for $75,000, but now the FMW is $150,000. You’ll pay capital gains on the difference in price from when you purchased the asset and when you transferred it to the business.

Here are the calculations broken down:

Original purchase price: $75,000

Present day FMV: $150,000

$75,000 – $150,000 = $75,000 in capital gains

Calculating the fair market value of a business

There is another time when FMV is used: buying and selling a business. While many Canadian business owners start their own company, some people buy them. And, in that case, it’s important to understand the value of the business assets for income tax purposes.

When you buy a small business, you’ll pay an agreed-upon price, typically as a lump sum or in several instalments. Sometimes your sale agreement sets out a price for each asset within the business, like inventory, land, machinery, and even goodwill, which estimates the value of the business’s reputation. 

As the buyer of the business, you can use the prices established in the agreement to set up your initial balance sheet, including your fixed assets, for future CCA calculations. If your contract doesn’t list the values of each asset, you’ll need to calculate the FMV of each asset. Any price paid over and above the cost of each asset should go toward goodwill.

For example, if you buy a business for $500,000, the FMV of the assets may be broken down as follows:

It’s important to note that not all the assets listed above are fixed assets and eligible for CCA. For example, property, manufacturing equipment, and goodwill are eligible; while accounts receivable and inventory are not. For those assets that are eligible, you can use these values to claim CCA for each applicable asset properly.

New business owners commonly transfer personal assets to a business, but it’s important to follow the right steps and rules. If you don’t transfer your personal assets correctly, you may not be able to claim CCA tax deductions, or find yourself paying more capital gains taxes than expected.