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? In this blog, we’ll dive into the details of arm’s length sales, how they differ from other types of transactions, and why understanding this concept is key for successful real estate deals.

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

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 sometimes called, are real estate transactions in which a personal or financial relationship between the parties gives one an advantage over the other.

How Do Arm’s Length Sales Differ from Others? 

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

Relationship Between Parties 

In an arm's length sale, the buyer and seller have no personal or financial relationship with each other.

This contrasts with non-arm's length transactions, where the parties may have a familial, personal, 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 an arm-in-arm 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

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.

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

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.

This is why real estate agents should only consider arm’s length sales for inclusion in a comparative market analysis (CMA).

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 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 arm-in-arm sales can compromise their professional ethics.

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

Examples of an arm’s length sale in real estate are a home being sold from one stranger to another or a retail property being sold between unrelated businesses.

Common examples of arm-in-arm transactions include a home being sold between family members or an office space changing hands between a parent company and its subsidiary.

When Is an Arm’s Length Sale Required or Encouraged? 

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

Tax Assessments 

As benchmarks for property valuation, tax authorities rely on arm's length transactions to calculate property taxes. If your property is sold arm-in-arm, you can’t expect your sale price to be the basis for your property tax.

Mortgage Financing 

Lenders and financial institutions prefer arm's length transactions when providing mortgage financing because an arm’s length sale will align with the fair market value.

Most lenders require an official real estate appraisal before approving a loan because the property value influences the loan amount, down payment, and interest rates offered to the borrower.

Lenders may approve a loan in non-arm’s length sale but typically not without imposing special conditions. That’s because arm-in-arm transactions come with a greater risk of the buyer and seller collaborating at the lender’s expense.

Legal Proceedings 

In legal matters, such as divorce settlements, property partition, or probate cases, an arm's length sale may be mandated to ensure that the property is sold at a fair market value without any influence or bias from involved parties.

Investment Transactions 

In real estate investment deals, especially those involving partnerships, joint ventures, or syndications, an arm's length sale is necessary to protect the interests of all parties involved and to ensure fair dealings.

Government Programs 

Certain government programs and incentives may require arm's length sales to prevent abuse or manipulation of the benefits offered. This is common in programs like first-time homebuyer grants or affordable housing initiatives.

Insurance Claims 

In cases of property damage or loss, the property’s pre-incident value will be based on an arm's length value. As with property taxes, you can’t expect the insurance company to honor the price paid during an arm-in-arm sale.

Regulatory Compliance 

Some jurisdictions or industries have specific regulations that require transactions to be arm's length to avoid conflicts of interest and ensure fair practices.

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

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.

While arm-in-arm sales aren’t illegal, it’s important to be aware of the line between arm’s length sales and arm-in-arm sales.

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 arm-in-arm 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

Real estate practice 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 states require continuing education (CE) for the renewal process is to keep important knowledge fresh, 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.

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Written and Published by: VanEd