When buying or selling a home in Massachusetts, you will be asked whether the transaction is arm’s length. Your answer is legally binding and could have certain implications. Before answering, it is important to understand what it is and why it’s even asked in the first place. Here’s a quick overview of arm’s length transactions in real estate for Massachusetts home buyers and sellers.
Definition of Arm’s Length
When something is arm’s length, it means that the parties involved are not related in any way. One party does not have an interest in or benefit from the actions of the other. Essentially, an arm’s length transaction involves two independent parties looking out only for their own interests. Thus, one family member selling a home to another would NOT be arm’s length. However, two people who simply know each other can still be arm’s length, so long as neither can benefit financially from the actions of the other. For instance, two parents who are merely part of the same PTO group would be arm’s length, but two people who are investors in the same company would not be.
Why Arm’s Length Transactions in Real Estate is Important
In real estate, market values are determined by buyer and seller actions/motivations. Sellers obviously want to sell for as high a price as possible, and buyers want to negotiate the lowest price possible. These two opposing forces create a balance that determines market value. Other things then rely on that value, such as municipal transfer taxes and federal/state income taxes.
When a transaction is arm’s length, we can assume that the agreed upon sale price is a reflection of current market value. When a transaction is not arm’s length, the price could be more or less than market value. For example, in a real estate transaction among family members, it’s possible that one relative might sell a home to another for much less than market value. In this case, the municipality will collect less in transfer tax dollars. Additionally, the seller will be reporting less profit on the sale, which again could result in lower capital gains taxes.
Non-arm’s Length Transactions
Sales that involve related parties are certainly legal and take place all the time. However, the sale could be treated slightly differently. For example, taxes might be calculated on appraised value rather than sales price. Reporting of capital gains may vary as well. Since the affidavit regarding an arm’s length transaction is a legal document requiring the signatures of both parties, it is critical to answer the question truthfully! The transaction will then be handled as such to comply with all applicable laws. Non-arm’s length transactions can still close smoothly and on-time with cooperation and proper disclosure by all involved.