Arm's Length Transaction

A transaction in which the buyers and sellers of a product act independently and have no relationship to each other. The concept of an arm's length transaction is to ensure that both parties in the deal are acting in their own self interest and are not subject to any pressure or duress from the other party.

Investopedia Says:
The concept of an arm's length transaction commonly comes into play in the real estate market. When determining the fair market value of a piece of property, the price for the property must be obtained through a potential buyer and seller operating through an arm's length transaction, otherwise, the agreed-upon price will likely differ from the actual fair market value of the property.

For example, if two strangers are involved in the sale and purchase of a house, it is likely that the final agreed-upon price will be close to market value (assuming that both parties have equal bargaining power and equal information about the situation). This is because the seller would want a price that is as high as possible and the buyer would want a price that is as low as possible.

This contrasts with a situation in which the two parties are not strangers. For example, it is unlikely that the same transaction involving a father and his son would yield the same result, because the father may choose to give his son a discount.

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Transaction that is conducted as though the parties were unrelated, thus avoiding any semblance of conflict of interest. For example, under current law parents may rent real estate to their children and still claim business deductions such as depreciation as long as the parents charge their children what they would charge if someone who is not a relative were to rent the same property.

Transaction among parties, each of whom acts in his or her own best interest. Transactions between the following parties would, in most cases, not be considered arm's length: a husband and wife; a father and son; a corporation and one of its subsidiaries.

A transaction among parties, each of whom acts in his or her own best interest.
Examples: Transactions between the following parties would, in most cases, NOT be considered arm's length:

• a husband and wife

• a father and son

• a corporation and one of its subsidiaries