What Is an Arm’s Length Sale in Real Estate?

In real estate, not all transactions are created equal. One common type of transaction that every agent and buyer should understand is an "arm’s length sale." But what does this term actually mean? As a trusted provider of real estate pre-license and continuing education, we’re here to help.

In this blog, we’ll dive into the details of arm’s length sales, how they differ from other real estate transaction types, and why understanding the concept is so important.

What Is an Arm’s Length Sale?

In real estate, an arm’s length sale is a real estate transaction between unrelated parties who are each acting in their own best interest.

This term may seem a bit odd until you define its opposite: a non-arm’s length sale.

Arm-in-arm sales, as they’re also sometimes called, are real estate transactions in which a personal or financial relationship between the parties gives one an advantage over the other.

Examples of Arm’s Length Sales vs. Non-Arm’s Length Sales

To make this concept concrete, here are common real-world scenarios where the parties are truly independent and the price reflects open-market conditions. Use these as quick reference points when evaluating whether a sale supports fair market value and appraisal standards.

Examples of Arm’s Length Sales

Residential Resale Between Strangers

A homeowner sells to an unrelated buyer found through the open market (MLS). Negotiated price reflects fair market value and supports appraisals and CMAs.

Commercial Deal Between Unrelated Businesses

One independent retailer purchases a storefront from another unaffiliated company. Terms are negotiated at arm’s length and mirror market conditions.

Examples of Non-Arm’s Length Sales

Family Transfer

A home is sold or gifted at a discount (“gift of equity”). The price may not reflect market value and can raise appraisal and tax considerations.

Corporate Transfer

An office building changes hands within the same corporate family. Internal priorities can influence price and terms beyond market factors.

Key Features of Arm’s Length Transactions

There are a few primary ways in which arm’s length real estate transactions can be distinguished from non-arm’s length transactions.

The Relationship Between the Parties

In an arm's length sale, the buyer and seller have no pre-existing personal or financial relationship.

This contrasts with non-arm's length transactions, where the parties may have a familial, personal, and/or financial relationship.

Independence and Fairness

Since arm’s length sales are between unrelated parties, there’s an assumption that the parties have equal bargaining power. This allows them to act solely in their own self-interest. In other words, neither party has an advantage over the other.

In a non-arm's length transaction, the pre-existing connections can impact the fairness of the deal by creating power dynamics where one party has more influence over the terms.

Property Valuation

Does an arm’s length sale affect appraisal? Yes.

Since each party is acting to maximize the value to themselves in an arm’s length transaction, the purchase price has to be negotiated according to market forces and fair requirements.

As a result, property valuation is based exclusively on arm's length sales. They serve as a benchmark for real estate appraisals, mortgage loans, and property tax assessments.

Meanwhile, non-arm's length transactions are complicated by factors beyond the value of the property being transacted. One party might compromise its position to accommodate the other's demands, potentially skewing the final price in favor of one individual. This means that non-arm's length real estate transactions may not reflect market conditions or provide an accurate representation of the property's value.

As a real estate agent, you must remember to exclude non-arm's length sales in a comparative market analysis (CMA). The CMA should be based on arm’s length sales only.

Regulatory, Legal, and Professional Considerations

For all the reasons above, tax assessments, financing arrangements, and legal disputes often require arm's length transactions to ensure compliance with various laws and avoid fraudulent practices.

Non-arm’s length transactions can also present conflicts of interest for real estate professionals like appraisers, agents, and brokers. These professions often have mandatory ethical standards that include acting impartially and providing unbiased advice to their clients. Working on non-arm's length sales can compromise their professional ethics.

When Is an Arm’s Length Sale Required?

An arm's length sale may be required in specific situations to ensure fairness, transparency, and compliance with regulations. Here are some examples.

The Role of Real Estate Agents in Arm’s Length Sales

The involvement of a real estate agent is crucial in an arm’s length sale to act as a neutral facilitator and act only in their client’s best interest. It’s one of the reasons some states outlaw dual agency deals – one professional simply can’t adequately represent both parties’ best interests.

It’s a real estate agent’s responsibility to maintain fairness and transparency in their professional life so that all parties in an arm’s length sale can pursue their interests with the necessary information.

Real estate agents also play an important role in non-arm's length sales. The ethical trickiness of the transaction makes adherence to best practices even more important. In a non-arm’s length transaction, real estate agents must be especially careful to avoid misrepresentation or concealment that might exacerbate the inherent power imbalance between the parties. Additionally, a real estate agent must be more careful to accurately establish property value and keep the terms of the transaction commensurate. Otherwise, you risk entanglement in tax avoidance, mortgage fraud, and a host of other legal woes.

Most of all, it’s a real estate agent’s job to recognize the hallmarks of both real estate transaction types and proceed accordingly. You have to know the signs that something might be a non-arm’s length sale so you can head potential problems off at the pass.

Common Pitfalls or Misconceptions

The differences between arm’s length and non-arm’s length sales aren’t always completely clear-cut. Distressed property sales, family transfers, and foreclosures can all blur the line.

Here are a few misconceptions or pitfalls related to real estate transaction types that you should be aware of.

Only Strangers Can Complete Arm’s Length Transactions

Based on everything we’ve outlined above, it’s easy to assume that it’s impossible for parties with a personal or financial relationship to complete an arm’s length transaction.

This simply isn’t true. The status of the transaction does not relate to familiarity but to independence and negotiating power. If each party is acting in its own interest without complicating factors, it is an arm’s length transaction. That said, it’s especially important in muddier cases that the agreed-upon sales price be based on market conditions.

Fair Market Price Is Easy to Find

Speaking of which, the trouble with basing your sales price on market conditions is that pinning down a property’s fair market price might be difficult.

There’s always wiggle room in the fair market value – that’s why parties have to negotiate in the first place. But when you’re trying to keep things above board for a non-arm's length sale, parties may have difficulty agreeing on a sale that qualifies as comparable.

Documentation Doesn’t Matter

When the status of a transaction is called into question, any undotted i’s or uncrossed t’s can get you in big trouble. Completing all documentation by the book and keeping it current with changes in business operations or marketing conditions are crucial to surviving an audit.

Why Does It Matter Whether a Transaction is Arm’s Length?

While non-arm's length sales aren’t illegal, it’s important for real estate professionals to be aware of the line between arm’s length sales and non-arm's length sales for a number of reasons.

First, as we just saw, arm’s length transactions are required in some cases. In order to simplify loan approvals, qualify for government programs, or complete a sale being made for specific purposes, you need to make an arm’s length sale.

Second, only the property value from arm’s length sales will be used to determine property taxes and insurance claims.

Third, arm’s length real estate transactions and non-arm's length transactions undergo a different level of legal scrutiny because there’s a higher chance of fraud.

Finally, the IRS may watch non-arm’s length transactions more carefully because they can be used to circumvent the federal tax limit on gifts. If someone sells property to another at a deep discount, it’s called a gift of equity, and it has tax implications that must be obeyed.

Learn More with Online Continuing Education

The practice of real estate requires understanding all kinds of terms and concepts like an arm’s length sale to navigate the market successfully (and legally!).

You probably learned about most of these concepts initially in your pre-license coursework, but one of the reasons that state real estate boards require continuing education (CE) for the license renewal is to keep important knowledge fresh and up to date, even if you don’t use it very often.

We have approved online CE courses in most states. They’re self-paced, mobile-friendly, and convenient. They can help you meet your renewal requirements whenever and wherever you have time.

Head to our website today to get started!