If you’re buying or selling in New York City, you’re going to get hit with a bunch of real estate terminology, some of which you might recognize in listing descriptions (“foyer”) to ones you might not (“maisonette“). But when it comes to the contract portion of the deal, that’s when the legalese really starts flying. One term you might hear is “arm’s-length transaction.” And while it sounds scary and confusing, it’s simply a term that describes what happens every day in real estate.
What Is an Arm’s-Length Sale?
In real estate, an arm’s-length transaction is simply this: The buyer is trying to get the lowest price possible and the seller is trying for the highest price possible. They are each acting in their own self-interest, trying to get the best price they can for themselves. In other words, they are negotiating according to the market and there are no outside influences or relationships that might be impacting their motivations, interests or objectives.
The Importance of Fair Market Value
Why is it so important that the buyer and seller act in their own self-interest? Ultimately, it guarantees that the transaction is occurring at fair market value. Not only does fair market value help set price for comparable sales, it also allows tax authorities to appropriately evaluate assessed values and collect appropriate property taxes.
So What Sales are Not Arm’s-Length Transactions?
The most straightforward real estate transactions are typically arm’s-length, but there are some scenarios that are not. Here are some:
- Transactions between family members
- Transactions between employers and employees
- Transactions between business corporations or LLCs and owner of the same entities
- Transactions between businesses with the same owner
- Transactions involving trusts and their beneficiaries
- Transactions where buyer or seller are being pressured by illicit means
What Happens When a Transaction is Not Arm’s-Length?
The most immediate impact of a transaction that is not at arm’s-length is that the property sale is likely not taking place at the fair market value. Unless properly documented and acknowledged in the contract, this type of transaction may draw the ire of taxation authorities, who may pursue parties involved to collect taxes and fines.
According to Lior Aldad, a Manhattan real estate attorney at Aldad & Associates, unless disclosed ahead of time, condos and co-op transactions that transpire at less than market value can have major repercussions. In the case of condo sales, the board of managers may exercise their inherent right of first refusal to acquire the apartment below market value. In the case of co-op sales, the board may outright reject the application and prevent the transaction from proceeding. It is always recommended to consult an experienced real estate attorney when dealing with transactions that are not arms length to prevent any mistakes down the road.
Are Non-Arm’s-Length Sales Illegal?
As long as the relationship is indicated within the contract, there is nothing illegal about a transaction not conducted at arm’s-length. However, if not appropriately documented, then there may have legal consequences. Also, if a home is sold that is not arms-length, and it is sold for a price appreciably under the fair-market value, the taxing authority could force taxes to be paid according to the market and as an arm’s-length transaction.
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