In every real estate transaction, buyers and sellers ideally act in their own best interest. Buyers want to get the lowest price possible; to reduce the price they must pay outright or borrow from a lender. Sellers seek the highest price possible so they can make the greatest profit.
An arm’s length real estate transaction is when the buyer and seller act independently out of their own best interest — without influencing the other party’s decisions. An example of an arm’s length transaction is a commercial buyer who purchases a river ranch from a seller they have never met. The two parties have no existing personal or business ties.
The opposite of an arm’s length real estate transaction may be referred to as simply a “non-arm’s length real estate transaction” or an “arm-in-arm transaction.” Non-arm’s length real estate transactions involve two parties who do have personal or business ties prior to the sale. Examples may include a nephew who buys waterfront land from his uncle or a subsidiary of a parent company who purchases the land from another subsidiary of the same company.
Why Arm's Length Transactions Matter in Real Estate
In an arm’s length transaction, the buyer and seller make decisions on the deal based on their own vested interests.
This has two key benefits:
- Maintain market integrity: By ensuring both parties act independently and in their self-interest, arm's length transactions reduce the risk of market manipulation or fraudulent practices.
- Accurate, comparable sales: Arm’s length transactions are often used as comparables in real estate appraisals. Appraisers typically rely on recent arm's length sales in the local area to establish the market value of a property. When deals aren’t conducted at arm’s length, it can result in the buyer paying a lower price than the true market value. This throws off the accuracy of comparables, which are used to determine the pricing of other properties.
Arm’s length real estate transactions help to encourage fair practices and protect the greater public.
The Legal Implications of Non-Arm's Length Transactions
Non-arm's length transactions aren't inherently illegal or unethical.
However, sometimes, they can be.
“Real estate flopping,” for instance, is a term used to describe when buyers and other participants take advantage of the short sale process to make a profit.
Maybe a real estate broker gets an appraiser to assign their property a lower value than what it’s actually worth. Then, the broker encourages a buyer they know to offer the lower asking price, based on that value. The buyer then purchases the house, turns around and flips it to another seller on the same day or relatively soon afterward — for tens of thousands more. These insiders may all be working together with a plan to split the profits.
This is illegal, of course, and is generally considered “collusion fraud.” That describes when two entities (like a buyer and seller) work together to launder or steal money.
If the property sold in a non-arm's length transaction is later subject to capital gains tax, the IRS may dispute the declared property value, as it may not reflect the true market value.
Additionally, lenders might not approve a mortgage for a non-arm's length transaction due to the increased risk of fraud.
There are other instances of non-arm’s length transactions that aren’t illegal. For example, if the uncle we mentioned earlier sells his nephew the waterfront land at a fair price, which aligns with its true market value.
Ensuring Your Transaction is Arm's Length
To ensure your real estate transaction qualifies as arm's length, it's crucial to engage the services of an independent real estate broker who can provide objective guidance.
A full-service brokerage firm, SVN Saunders Ralston Dantzler offers commercial real estate clients unparalleled service and results.
Our personalized approach, defined advertising strategy, and expert professionals will help ensure a smooth selling or buying process.
Additionally, all terms and conditions of the sale should be in writing and signed by both parties. It’s also advisable to seek independent legal advice to understand potential tax or legal implications.
Understanding the concept of arm's length real estate transactions and their importance in the real estate market can help you make informed decisions when buying or selling property.
Whether you're navigating the real estate market as a first-time commercial buyer or an experienced investor, understanding this principle will serve you well.
To get started, call SVN Saunders Ralston Dantzler at 877.518.5263.
Disclaimer: This article is only intended for informational purposes. SVN | Saunders Ralston Dantzler does not guarantee the sufficiency of the content in or linked to from this article or that it complies with current law. The content within this article is not a substitute for legal advice or legal services. You should not rely on this information for any legal purpose without consulting a licensed lawyer.