what is an arm s length transaction 
an arm s length transaction refers to a business deal in which buyers and sellers act independently without one party influencing the other arm s length transactions assert that both parties act in their own self interest and are not subject to pressure from the other party they also assure others that there is no collusion between the buyer and seller in the interest of fairness both parties usually have equal access to information related to the deal understanding arm s length transactionsarm s length transactions are commonly used in real estate deals because the sale affects not only those who are directly involved in the deal but other parties as well including lenders if two strangers are involved in the sale and purchase of a house the final agreed upon price is likely close to the fair market value fmv assuming that both parties have equal bargaining power and the same information about the property the seller would want a price that s as high as possible and the buyer would want a price that is as low as possible otherwise the agreed upon price is not likely to differ from the property s actual fmv as noted above the buyer and seller aren t the only ones involved in an arm s length transaction this type of transaction also has a direct impact on the financing needed from a bank as well as municipal and local taxes the transaction can also influence comparable prices in the market arm s length vs non arm s length transactionsfamily members and companies with related shareholders generally don t engage in arm s length sales instead the deals between them are non arm s length transactions this type of transaction which is also known as an arm in arm transaction refers to a business deal in which buyers and sellers have an identity of interest put simply buyers and sellers have an existing relationship that is either business related or personal an existing relationship tends to influence the terms of a non arm s length transaction for instance it s unlikely that a transaction involving a father and his son would yield the same result as a deal between strangers because the father may choose to give his son a discount if the sale of a house between father and son is taxable tax authorities may require the seller to pay taxes on the gain he would have realized had he been selling to a neutral third party they would disregard the actual price paid by the son in the same way international sales between non arm s length companies such as two subsidiaries of the same parent company must be made using arm s length prices this practice known as transfer pricing assures that each country collects the appropriate taxes on the transactions 1tax laws throughout the world are designed to treat the results of a transaction differently when parties are dealing at arm s length and when they are not 2arm s length transactions and fair market value fmv as noted above one of the main benefits of arm s length transactions is that the transaction is fair and equitable this is especially true when it comes to real estate deals when the buyer and seller have no previous relationship the terms of the deal notably the sale price accurately reflect market conditions rather than being influenced by other factors this value is referred to as the fair market value fmv is the best possible price that a neutral and impartial seller and buyer are willing to accept and pay to close the deal the following are just some of the factors that are used to determine the fmv of a home of course other factors also work into the fmv of a home including interest rates and the condition of the overall economy example of an arm s length transactionlet s use a hypothetical example to show how arm s length transactions work we can start by expanding on the example above using the father and son and the real estate transaction for clarity s sake let s say the father s name is john and the son s name is henry assume that john is selling his home and puts the house up for sale for 350 000 he gets an offer for that amount based on the fmv the potential buyer looked at some of the factors affecting the value including the location amenities and comparable homes if the sale goes through it s considered an arm s length transaction but henry throws john a loop saying he needs a new place and would like to buy the home for himself he offers a lower price of 275 000 since it s his father who s selling the house if john decides to accept he would be conducting a non arm s length transaction 