What to expect from non-arm’s length transactions

Buying or selling a house from someone you have an existing relationship with can seem easier. You both know the home’s condition and you may discuss a relationship discount. We’ll help you avoid pitfalls like additional liabilities and help you understand the tax implications as you navigate a non-arm’s length transaction.

Key takeaways

• Non-arm’s length transactions occur when one or more parties to a transaction have an existing relationship with each other outside of the sale.
• Being upfront and getting professionals involved to handle the finer points of the agreement can help limit the tensions that can arise when doing a financial transaction with someone close to you.
• Mortgage lenders and the IRS may place more scrutiny on non-arm’s length transactions, looking for mortgage and/or tax fraud.

Understanding arm’s length and non-arm’s length transactions

Most home purchases are arm’s length transactions, meaning that there’s no prior relationship between any of the parties to the transaction. In a non-arm’s length transaction, there is a direct relationship between two or more of the parties. Let’s look at the following example scenarios

A non-arm’s length transaction may occur if you buy or sell from your father, and it also applies if your sister sells the home to you as the builder. It also applies on the lending side, so it can be considered a non-arm’s length transaction if your brother is your loan officer.

Who is considered ‘non-arm’s length’?

Depending on the type of loan you’re applying for, lenders may consider any of the following non-arm’s length relationships:

• Family
• Friends
• Employer
• Landlord
• Business partnerships

When it comes to family, all the following may be considered non-arm’s length transactions including former and future familial relationships. The relationship between step, foster and adapted relatives can also count as non-arm’s length. These relationships include:

• Children
• Parents
• Grandchildren
• Grandparents
• Godparents
• In-laws
• Spouses
• Siblings
• Aunts and uncles
• Nieces and nephews

How non-arm’s length transactions work

If you’re doing a real estate transaction involving a prior relationship, here are the steps you can take to make sure things go smoothly.

1. Have an honest conversation

Before moving forward with a non-arm’s length transaction, all parties should make sure they have a frank conversation on their expectations for the transaction and about the property itself. Some may fear this could be seen as confrontational, but it doesn’t have to be. All parties should go in with eyes wide open and no surprises:

• What are the parties thinking in terms of sale price? This doesn’t need to be fully defined at this point, but having a range of expectations lets both parties know up front whether a deal will be workable and helps avoid animosity later in the process.
• What’s the current mortgage situation on the home? Does the buyer expect to be able to assume the mortgage or will they be getting financing? If assumption is on the table, check with the lender or servicer to make sure the terms of the loan allow it.
• Does the homeowner have maintenance records for the home? What are the most recent estimates they may have received regarding the lifespan of major systems, the roof, etc.?
• Will a seller need to stay in the home for a period after the transaction? In some cases, this can affect your financing options.

Negotiating with family and friends can bring emotions into a financial transaction. To avoid hard feelings, make sure this conversation is thorough.

To the extent that any deal you would get on the property would affect what you could expect to receive from the other party in terms of future inheritance or inclusion in an estate, make sure you have that conversation as well. Taking care of these things may help avoid future discord.

2. Consider hiring an attorney

Hiring a real estate attorney could help you navigate the process of a non-arm’s length transaction. There are additional liability and tax considerations that don’t apply in an arm’s length transaction. The attorney can discuss how to handle this in a way that minimizes exposure.

Most of the time, the hiring of an attorney is optional, but some states may require a real estate attorney be present at closing.

3. Figure out what the property is worth

As part of settling on a price, it’s going to help to figure out what the property is worth. If you just want to get started with a ballpark figure, one option is to use a home listing site.

However, it’s likely worth going a step further and getting a professional involved. If the buyer plans on financing the purchase with a mortgage, the lender is going to require an appraisal or another form of property valuation anyway. The fair market value is also going to matter for tax purposes, so you’ll want to know exact numbers.

There are other costs to think about as well. Closing costs are typically 3% – 6% of the purchase price, although they may be lower for transactions between parties with an existing relationship because you may not employ a real estate agent to negotiate on your behalf.

4. Draft a purchase agreement

A purchase agreement is a legal contract that formalizes the conditions under which a buyer and seller agree to enter into a real estate transaction. It should include the following:

• Address of the property
• Purchase price
• Items that aren’t staying with the property
• How the property is being financed (mortgage or otherwise)
• Contingencies (buyer protections based on financing issues, appraisal, home inspections, etc.)
• Any agreements on who pays for what closing costs
• Earnest money agreements
• Timing of expected closing

States may have templates that you can use, but if you’re not comfortable, you may choose to hire an attorney for the purpose of hammering out the details.

5. Apply for financing, if needed

Unless you’re buying with cash, you’ll need to apply for financing. If getting the property at a discount, mortgage lenders will require a gift letter stating that the amount of the discount doesn’t need to be paid back. This gift of equity can be used toward your down payment.

Beyond that, the process is like getting a mortgage at any other time. Your credit will be pulled and you’ll be asked to share information about your income and assets for a down payment and reserves to make your mortgage payment if you lose employment temporarily.

How non-arm’s length transactions are regulated

The level of separation between the parties matters to both lenders and the IRS. Lenders must worry about mortgage fraud and the government wants to make sure it gets the appropriate amount of taxes.

Lenders have unique guidelines

Lenders have some special guidelines that come into play for non-arm’s length transactions:

• They may require documentation from the seller that they’re not too far delinquent on the loan so that the transaction isn’t a bailout.
• FHA has specific guidelines that require a minimum 15% down payment from the buyer on non-arm’s length sales. There are several exceptions to this, the most common being buying from a relative. In the event of an exception, the minimum down payment is 3.5%.

Short sales require specific affidavits

Short sales occur when a mortgage servicer approves selling a property for less than the outstanding balance of the mortgage because the fair market value of the property is less than the principal.

• As part of a short sale, all parties involved typically sign affidavits with several guarantees including that the property is being sold for fair market value.
• Typically, the affidavit states that it must be an arm’s length transaction, but some states disallow this clause.

The IRS may tax the transaction

Consult a tax advisor on your specific tax situation. Here are some considerations to think about:

• If your gift of equity property discount is greater than $19,000 for the 2025 tax year, you must declare it on your taxes. Most people don’t end up paying estate and gift taxes because the lifetime exclusion limit is quite high – $13,990,000 in 2025. But gifts above the $19,000 annual exclusion must be reported.
• The seller may also be subject to capital gains tax on profits from the home sale.

The bottom line: Prepare ahead of time when entering a non-arm’s length transaction

Because non-arm’s length transactions involve buying from someone closely associated with you, making sure that everyone involved is fully aware of what they’re getting, consulting experts, and making sure everything is clearly laid out in the purchase agreement can avoid hurt feelings down the road.

Given the nature of these transactions, they may also be subject to extra scrutiny. Lenders have unique guidelines to protect against mortgage fraud. At the same time, the IRS has rules around declaring capital gains as well as when gift tax is owed. If you have any doubts, you should consult a real estate attorney and tax advisor.

If you feel ready to buy, you can apply online.