Owning a home in Texas is a dream for many, but how can you make sure you’re not being duped as a first-time homeowner? How do you know you’re not being overcharged, or whether you’re paying Fair Market Value for your new home? Fortunately, the team at Bezit is here to help you understand all the technicalities related to homeownership, starting with establishing the right value for your home.
When buying a home in Texas, there’s a market value associated with each property. The market value of a property is how much the seller is willing to accept and a buyer is willing to pay for a property. Obviously, the seller would want to make as much profit as possible, while the buyer wants to save. With two such differing motives, how can they agree on an amount that is fair to both parties? This is where an Arm’s Length Transaction comes into play.
What is an Arm’s Length Transaction?
In business terms, an Arm’s Length Transaction is a deal between two independent parties to ensure a fair and equal transaction for all involved. To put it simply, it’s a business deal between people who are not related or connected to each other in any way. This ensures that no single party benefits unfairly from the deal and a fair value is received.
These sorts of transactions usually take place in the real estate industry. Remember when we mentioned the market value of a property? Well, an Arm’s Length Transaction is done to make sure a Fair Market Value (FMV) is set for a property.
Why is it so important?
You might be wondering why Arm’s Length Transactions are important. Well, first and foremost, it helps set the Fair Market Value of a property, which has multiple legal and tax implications. For instance, a seller will need to pay taxes on their sold property depending on the FMV. If the seller has not received a fair share, they may have to pay a higher tax based on the FMV of that property.
Let’s consider an example where an individual’s property has a Fair Market Value of $500,000, but they’ve accepted $350,000 in a Non-Arm’s Length Transaction; they will be expected to pay taxes on $500,000, which would be a significantly higher amount. Thus, we can say that an Arm’s Length Transaction is extremely important in establishing the correct Fair Market Value for a property, so that neither party loses out.
If you want to know how much property tax you will need to pay for your home or homestead in Texas, you can always check out Bezit’s informative page on Property Tax Bills.
Isn’t Fair Market Value and an Arm’s Length Transaction the same thing?
Not exactly. The Fair Market Value of a property is the price at which the property would normally sell on an open market. This is usually decided based on the property location, conditions, and the valuation of similar properties.
On the other hand, an Arm’s Length Transaction is a fair deal made between two parties who have no prior or personal connection with one another.
While the two sound similar, the main difference is that Fair Market Value is the estimated price that would result from a deal like an Arm’s Length Transaction. Basically, the transaction helps establish the fair market value for a property.
What does an Arm’s Length Transaction look like?
As a prospective property owner, you may be curious as to what an Arm’s Length Transaction looks like. Well, a real-life example might help. Let’s assume that Susan wants to buy a house in Texas. After some research and checking out the value of different houses, she finds the perfect choice. Based on the area, the amenities being offered, and the prices of other homes, she is willing to make an offer of $500,000. If the seller is agreeable to the amount and the sale goes through, that would be considered an Arm’s Length Transaction. If the seller doesn’t agree, the negotiations could continue until a price is agreed upon by both parties.
In this transaction, Susan has no vested interest in the property or a relationship with the property owner, which may affect the price of the house. The amount she is willing to pay—and is agreed to by the seller—is fair to her and the seller, thus making it a “fair value” for the property.
Are there other kinds of sales?
While in the non-real estate industry there are different kinds of sales, such as arm-in-arm transactions, there is only one other kind of major sale in real estate. It’s basically the opposite of an Arm’s Length Transaction, and we’ll talk about that below.
What’s the opposite of an Arm’s Length Transaction?
The existence of a fair, Arm’s Length Transaction implies the existence of a Non-Arm’s Length Transaction. In the real estate industry, when there is a connection between the buyer and seller that influences the price of a property, it’s called a Non-Arm’s Length Transaction. This kind of a transaction may lead to skewed tax amounts being paid by one party, or not receiving the benefits of a Fair Market Value for the property.
Usually, a Non-Arm’s Length Transaction involves any kind of sale where the seller and buyer are associated with each other outside of the transaction taking place. Does this mean that one party is going to be treated unfairly? Not exactly. Non-Arm’s Length Transactions usually take place between parties who know each other and are willing to make this kind of a transaction—like a father selling his home to his daughter, or a friend selling their home to another friend. In either case, both parties must agree on the price before the sale goes through.
What’s an example of a Non-Arm’s Length Transaction?
Let’s continue with the example of Susan. Say Susan has a close, childhood friend in Texas who is selling their home. However, due to the locality and amenities, the price of the house is slightly beyond Susan’s budget.
Due to her relationship with the seller, Susan may be able to buy the property at a discounted price. This means that the seller, instead of selling their property at the Fair Market Value of $600,000, would sell it to Susan at $500,000. The seller does this even if they could potentially get $600,000 from a different buyer in an Arm’s Length Transaction. Why? Because Susan is their friend and they want to go through with the transaction.
On the other hand, the property could also be valued at $450,000, but Susan pays the seller $500,000 due to their history and relationship. These are the ways in which a Non-Arm’s Length Transaction may occur.
How Are They Different?
There are a few ways in which an Arm’s Length Transaction differs from a Non-Arm’s Length Transaction. The first is the relationship shared by the two parties. In the former, there is no personal connection between the two parties outside the sale of the house. In the latter, the two parties have a shared connection or relationship that somehow influences the sale.
Secondly, the price being paid in each case is different. In an Arm’s Length Transaction, the Fair Market Value of the property is the amount paid, with both parties being agreeable to the final price. In a Non-Arm’s Length Transaction, the final price of the property is influenced, and it is not the Fair Market Value of the property.
Finally, with an Arm’s Length Transaction, there are no tax adjustments that need to be made by either party. Both parties pay taxes based on the Fair Market Value. On the other hand, with a Non-Arm’s Length Transaction, either party may end up owing more tax, since the property is not being sold at the Fair Market Value.
How Do I Decide What To Do?
As a first time homeowner in Texas, you should look into the taxes imposed by your local government before deciding what kind of transaction works best for you. Either way, you should opt for the option that you benefit from the most. Remember, sometimes a Non-Arm’s Length Transaction may seem like a better option in the moment, but could lead to more taxes in the future. Whereas, with an Arm’s Length Transaction, you know that you have the transparency of a Fair Market Value being taxed.
No matter what you choose, know that Bezit has your back. If you feel that you’ve been wrongly taxed on your property, you can always file a protest. Buying a new home is an exciting journey, and you can enjoy it without any worries when the experts are on your side!