The businessman was the Vatican’s fiduciary for a deal in which its Secretariat of State spent millions on a luxury residence in Chelsea district several years ago.
Vatican prosecutors are investigating allegations of corruption surrounding the purchase in 2012.
Mr Torzi is the first person to be arrested in the probe.
It is rare for an Italian citizen to be arrested and held in the Vatican. Most arrested in the past have been either Vatican citizens or Italian employees of the tiny city-state.
In a statement, the Vatican said the charges of which Mr Torzi stands accused carry a 12-year prison sentence if he is convicted.
The businessman was arrested following questioning by Vatican magistrates.
The investigation into the London property deal has also led to the suspension of five Vatican employees, the resignation of the Vatican‘s police chief and the departure of the former head of the Vatican‘s Financial Information Authority (AIF).
The probe became public in October last year when Vatican police raided the offices of the Secretariat of State - the administrative heart of the Catholic Church – and the offices of the AIF, during which documents and computers were seized.
In February, Vatican police raided the home and office of a priest who was working in the Secretariat of State at the time of the purchase and said he was suspected of embezzlement, abuse of office and corruption.
In the same month, Cardinal Angelo Becciu, a former top official at the Secretariat of State, said the value of the London property had tripled since it was purchased but claimed the middlemen had acted improperly in their dealings with the Vatican.
Pope Francis and other Vatican officials have defended using Church money for real estate investments as long as they are ethical.
He said last year that Church money should not be “kept in a drawer” but allowed to grow so that it could be used to do more good.
It was not immediately possible to contact lawyers for Mr Torzi.
Additional reporting by agencies
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