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§2.14 GAINmarket, one not controlled by either the buyer or the seller. The price for goods isdetermined not by the parties, but by the economics of the marketplace. The lawof supply and demand operates freely to set the value of all assets in the market.As supply rises or falls, the cost of the good rises and falls in relation thereto. Asthe demand rises and falls, the cost of the good likewise rises and falls.The method used to arrive at the value of an asset is called valuation. Itattempts to ascertain the fair market value of an asset. The value is usually determinedin one of two ways. The first method is the cost, or actual, method of valuation.The value of an asset is considered to be the amount it costs a purchaserto buy the asset. This method purports to measure the actual or true value of theasset. The second method is appraisal. An appraisal is an estimate of the value ofan asset. It attempts to ascertain an asset’s fair market value by making an assessmentof various factors that a buyer and seller look to in making an exchange.The relative supply and demand, the cost of comparable goods, and the like areused to estimate an asset’s value.The actual cost of an asset may not be the same as its appraised value. Also,the fair market value of an asset may be different from both the cost and appraisedvalue of an asset. A purchaser may get a bargain sale and pay an amount belowthat of the market. Likewise, a seller may get a windfall by selling an asset formore than its value in the market. Also, buyer and seller may conspire to fix aprice that is not a fair value. Such economic dislocations are normal in an imperfectand real marketplace.For the most part, in arm’s length transactions between parties that are notrelated, the actual selling price of an asset is considered to be its value. Also,when an appraisal is made in good faith, it is considered to be representative ofthe asset’s fair market value.(a) BasisThe importance of valuation has to do with the measure of the amount of gainderived on the sale or disposition of an asset. Just as gross income is not, withoutreduction for costs of production, a clear reflection of economic gain, neither isthe total amount realized by the seller on the sale of an asset. The total amountrealized on a sale also reflects a return of the initial investment (the cost) in theasset. The return of the cost paid for an asset is not an accession to wealth, butmerely a return of previously accumulated and invested wealth. Likewise, coststo improve or enhance the asset are invested and returned as part of the purchaseprice. Therefore, a mechanism must be used to apportion those costsinvested in the asset and returned by the sales proceeds, and those sales proceedsthat represent an economic gain to the seller.Basis is the term that refers to the investment in property. The mechanism forapportioning investments in an asset is the general basis rules found in the federaltax law. 42 The tax basis for an investment in property is usually the cost ofacquisition of the asset. 4342 IRC §§ 1011–1023.43 IRC § 1012. 41