Arizona is a “community property” state. This means that most property acquired by either spouse during a marriage, including income earned by either spouse, is presumed to belong to the marital community or both spouses. “Most” because some property acquired during the marriage still may be characterized as one spouse’s sole and separate property. Common examples include property inherited by or gifted to one spouse or property acquired during the marriage but “disclaimed” by one spouse. Property acquired by each spouse before the marriage is also presumed to be separate property. During a divorce or legal separation in Arizona, the family court must equitably divide community property and confirm to each spouse his or her separate property. But what about separate property that was (at least) partially paid for or improved during the marriage with community funds? Is the non-owning spouse simply out of luck? Not necessarily, the non-owning spouse may be able to assert what is called a community lien against any community funds invested in separate property.
What is a Community Lien
A community lien is an equitable interest that may be asserted when community funds (or other community efforts, including labor) are used to pay for or improve the value of a spouse’s sole and separate property during a marriage. The idea is that when a marital community’s joint effort enhances the value of a spouse’s separate property interest, the community is entitled to a share of the increased value. This principle can be applied to real estate, retirement accounts opened prior to marriage, or any other type of tangible or intangible separate property that appreciates during a marriage as a result of community contribution. It is hugely important to correctly identify community interests early in the litigation. Before you file or respond to a petition for divorce, take advantage of a free consultation.
Disclaimer Deeds Can Create Community Liens
Arizona divorces and legal separations commonly involve community liens on real estate, even when purchased during the marriage. This is because lenders often require a spouse to execute a disclaimer deed to relinquish his or her interest in the property in order for the other spouse to qualify for financing. When a disclaimer deed is validly executed, the property becomes the sole and separate property of the other spouse. But because it is usually attached to a mortgage to be paid during the marriage, the other spouse often is entitled to an equitable interest in the property.
How Community Liens are Calculated
Arizona case law prescribes a slightly different formula to calculate a community lien depending if the property appreciated or depreciated during the marriage. Yes, even if the value of separate property depreciated during the marriage, the other spouse still may be entitled to a share of the value. These cases derive from the Drahos decision, where the Arizona Court of Appeals first established a “value-at-dissolution” formula to calculate the community interest as:
C + [ (C / B) x A ]
Under this formula, the community is entitled to the total principal contributions (“C”) plus the product of the principal contributions divided by the purchase price (“B”) multiplied by the appreciation during the marriage (“A”). The algebra can be confusing, even to inexperienced family law attorneys, but the community is essentially entitled to the principal of its investment plus the proportionate share of appreciation that resulted from that investment. It also should be noted that “principal” is not necessarily limited literally to the principal cost of the purchase. It also can include the cost of improvements or renovations that provably improved the value of property.
Let’s use a more concrete example. Imagine a married couple purchase a home for $500,000 but the husband is required to execute a disclaimer deed for the wife to obtain financing. $500,000, the purchase price, is represented by “B” in the formula. Now let’s say the couple pay $100,000 in principal between their down payment and mortgage payments made during the marriage. This figure is represented by “C” in the formula. Finally, let’s say the home appreciated to $550,000 during the marriage. The appreciation, $50,000 ($550,000-$500,000) becomes “A”.
Using these figures, the formula looks like this:
$100,000 + [ ($100,000/$500,000) x $50,000 ]
$100,000 + [ (0.2) x $50,000 ]
The community’s total interest in this hypothetical scenario would be $110,000. But that is not the end of the calculus because that figure represents the total community interest. If the family court divided the community property equally during the divorce, the wife would be entitled to half or $55,000.
This example illustrated how simpler community liens are calculated, but other inputs can complicate the calculus. First and foremost, this variation of the formula does not account for any premarital appreciation. So it may not accurately represent interests in property acquired by a spouse prior to marriage. This issue was addressed by the Arizona Court of Appeals in Barnett v. Jedynak.
Briefly, that case involved a home purchased by the eventual husband a few years prior to their marriage. At trial, the family court ordered the parties to calculate the equity in the home and divide it equally. The husband filed a motion to amend the judgment where he asked the court to adopt a different formula to reflect premarital appreciation. The wife appealed and ultimately the Court of Appeals modified the Drahos formula to reflect premarital appreciation by substituting the value as of the date of marriage for the purchase price as variable “B”.
Trying to keep a consistent example, let’s imagine that our hypothetical husband purchased a home for $500,000 prior to the marriage. Only this time, it appreciated to $525,000 before the marriage. Consistent with the previous example, the parties still made principal contributions of $100,000 and the home appreciated to $550,000.
The community’s interest would look like this:
$100,000 + [($100,000/$525,000) x $25,000]
Overall, this scenario would reduce the community’s total interest from $110,000 to $104,761.90.
Again, this is an area of Arizona family law where it is especially valuable to speak with an attorney. You can contact our experienced divorce attorneys for a free consultation.
Marital Depreciation to Separate Property
Now we will take a look at what happens if the value of separate property subject to a community interest depreciates during the marriage. It is possible for a spouse to maintain a community interest. The Valento v. Valento decision established the applicable formula to be:
C – [ (C / B) x D ]
“C” still refers to community contributions to principal and, similar to Barnett, “B” equals the value of the property on the date of the marriage. The difference is that “D” is introduced to reflect depreciation during the marriage. The Court of Appeals characterized this as a simple restatement of the Barnett formula to be applied in a declining market.
Using our last example, let’s imagine that the property depreciated during the marriage from its $525,000 value to $500,000. The community interest would look like:
$100,000 – [ ($100,000 / $525,000) x $25,000]
This formula looks nearly identical to the Barnett example, but the critical difference is the bracketed section is subtracted from the principal and not added to it. The community’s interest would total $95,238.09.
Because of the simplicity of these examples and the consistent variables we used, it may not be immediately apparent how much a community interest can vary depending on which formula is applied. But in practice, application of the wrong calculus or other mistakes may cost a litigant tens to hundreds of thousands of dollars. It is critical to fully understand the (a) character of the property and (b) to what interest, if any, each party is entitled.