Will BofA deny me because of the Arms Length Transaction clause?

You don't and will never have an arms length transaction. The fact that you're not a true relative of the guy is irrelevant. Not only do you have a business relationship going on five years old, you actually shared occupancy of the property in question. You putting a lot of money into a place that you were only renting despite knowing that mortgage payments had been stopped only makes the banks suspicion stronger that it was planned for the home to be let go with the intention of you buying it.