Arm’s Length Transaction Definition
An arm’s length transaction or the arm’s length principle is a transaction that takes place between two completely unrelated parties. An arm’s length transaction also implies that the final transfer of assets or services will be valued at the fair market value.
Arm’s Length Transaction Meaning
Arm’s Length Transactions are important in the market because it is implied that these transactions will provide consistent and meaningful information. This differs if the two parties are related or are friends, who might provide a discount for the transfer of assets or services. An arm’s length sale is most often referred to in the real estate market where the fair market value must be determined at arm’s length. This is because the sale of one property affects the price of all the properties surrounding it. If the parties are related there will usually be a benefit for each party in the agreed upon price and drawing the agreed upon price away from the fair market value.
Arm’s Length Transaction Example
Bob is attempting to sell his house in the market and move away. His son Bernie lives in the same city. He would like to keep the house in the family as it has been for years. Bob has the house appraised and it is worth $350,000. However, his son has just entered into a job last year right out of college. Thus, he cannot afford the house at fair market value. Therefore, Bob decides that he will sell the house for $150,000. This is not an arm’s length transaction because the two parties are related. Furthermore, the agreed upon price was discounted well below the fair value. If Bob had sold to a complete stranger for $340,000 this would be arm’s length because they are unrelated. Even though the price is slightly below the appraisal the agreed upon price is the result of negotiations between the two parties.