Could you clarify your #1 please?

I would not.
Appraisers can't use them either according to USPAP.

".... using sales that are not arm's length is not acceptable appraisal practice if an adequate number of relevant arm's length sales are available for analysis."

Unless:

"If market conditions result in the necessity to use sales that are not arm's length in an appraisal, the sale analysis must identify and apply appropriate adjustments to result in a value indication consistent with the terms and conditions of sale set forth in the market value definition applicable in the assignment. USPAP References:..."

If your market has a lot of bank sales I don't know how you can avoid using them as comps.

I beg to differ with my Bernie ;)

The appraisers didn't use them in the beginning of this Recession. Now I have seen some appraisers in my area give some credence to the distressed properties.

The entire RE appraisal system is a mess at the moment. It depends where you live, too. I have seen some very seasoned appraisers agonize over how to appraise some properties.
Bottom line: Some appraisers use them, others try not to.

"I beg to differ with my Bernie ;)"

Did you even read the USPAP quotes, which are mandatory for appraisers?

Bernie-

I am talking about REALITY in my area.

Last week I followed an appraiser around, who was appraising a house. He had been in the business over twenty years, and he was struggling with what to do....what to do...this time is so different.

Appraisals are all over the place.

"Appraisals are all over the place."

That's what happens whe USPAP guidelines are not followed, and appraisers don't know how to analyse their subject market as to include foreclosures/REO's or not, and the appraisals become worthless.

Apples and oranges, I think. The op is asking about comps, I assume provided by a realtor to guide in pricing to sell, not a professional appraisal to be used for lending, taxation, etc. That is, a "market analysis," not an appraisal. I'm guessing that any sale in the neighborhood is relevant to how you set your price since you are in competition with them, market value or not.

This is interesting. I came across a house (REO) the other day that is 50+k higher than all the other homes listed of similar sf, age, and lot size. I don't know how they can do this. I wondered if they used comps on the original purchase of the homes around it or on the current local market. This house is less than two years old and none of the others around it have been re sold yet.

"That is, a "market analysis," not an appraisal. I'm guessing that any sale in the neighborhood is relevant to how you set your price since you are in competition with them, market value or not."

Not any sale. Only if non arms lenth transactions are non existent should they be included.
If it's NOT a "comp", it can't be given the same weight as the others.

Should say:
Only if arms length transactions are not available, should they be included.

If there are quite a few foreclosures and short sales happening in the neighborhood, you better take them into account when pricing a home. A lot of these foreclosures are not your typical run down, ransacked homes. Plenty of them are pretty much move in ready. So potential buyers will see them as competition if your home has the same criteria.

One of the recent sales in our development was $245K, about $100K to 120K below the current comps, and "not arms length." I'm guessing possible "buyout" by partners/spouses that are spliting? I'm thinking that should not count?

The bank sales do tend to be lower than the "regular" sales, but not be that amount. Maybe $20K to $30K below.

Here is one appraisers answer to what market value is:
"Market value approach.

This type of appraisal compares the subject property to three comparable sales in the neighborhood.
If two comparable sales are regular transactions and one is a foreclosure or short sale, will the appraiser use that distressed sale as a comparable property? To get answers, I talked to Derek Yuke, an appraiser at Yuke & Associates in Sacramento.
Yuke tries to find arm-length transactions when putting together an appraisal. These are considered sales at market value, offered for sale by a willing seller and purchased by an able and willing buyer, with neither party under duress. Even if it means pulling comparable sales from an adjacent neighborhood and adjusting for value, most appraisers, he says, can find arm-length transactions to use in a appraisal.
Yuke has been in the business since 1996 and says,"If I do use a foreclosure, I explain why I used it. I say its not a good comp and donÂt give it a lot of weight." He says foreclosures do not represent market value, and he can always find regular sales to incorporate into his appraisals. "If there are only foreclosures in an area, then that affects market because it becomes the value," Yuke warns.
Foreclosure Sales Make HOAs Vulnerable
Yuke continues, "If there arenÂt any regular transactions, then youÂre stuck. A condo development is tough." What happens if there are only short sales or foreclosures within a homeownerÂs association? According to Yuke, those are the best comps for that development because they are the only comps available.
Distressed sales within a homeownerÂs association also means itÂs unlikely that the owner paid that unitÂs prorata share of the HOA dues. If the homeownerÂs association fund runs low, itÂs the other home owners who end up paying the tab in the form of higher association dues. Unfortunately, although many homeowner associations have the power to foreclosure if dues are in arrears, few have the money or means to do it, and those that do often forego the process when the mortgage amount is higher than the value of the unit.
How Foreclosures Weaken Home Prices
Although some studies show that neighborhoods with strong foreclosure numbers see a rough drop of 1% in value, itÂs not always due to sold value of the property. Often falling prices are due to buyers perception of the area, followed by a refusal to live in such neighborhoods, coupled with the previous ownerÂs extreme neglect of the property.
Some foreclosure sales appear to self perpetuate. Soon as one home owner goes into default, others nearby seem to follow. If the owner in default is evicted or abandons the property, the lawn isn't mowed, deferred maintenance takes over and the deserted home falls into disrepair. Homes with no curb appeal and screaming for repairs do not sell for market value.
Part of the drawback to buying foreclosures is the fact the homes are sold "as is," and buyers have no guarantee of condition. Sellers who are losing everything think nothing about trying to salvage some aspect of their desperate situation by selling the built-in appliances and ripping out the copper plumbing to sell for scrap."