Community Liens and Divorce or Legal Separation
A community lien is an equitable interest in an individual’s sole and separate property created when community funds (or other efforts including labor) are used to pay for or improve the value of the property during a marriage. The basic idea is that the benefit gained through community efforts should be enjoyed by the marital community and not only the spouse who owns the property. This equitable principle can apply to all types of property, but is most commonly used to calculate interests in separate real estate and retirement accounts.
Arizona is a community property state. This means that all property acquired by either spouse during the marriage is presumed to belong to the marital community, i.e. both spouses. This does not mean that a spouse cannot acquire separate property during the marriage. It just means that the party who claims the property is separate property must prove separate ownership by clear and convincing evidence.
A disclaimer deed is a legal document that relinquishes or gives up one spouse’s interest in real estate acquired during the marriage. Lenders often require disclaimer deeds when only one spouse qualifies for financing. When a disclaimer deed is validly executed, the property is acquired as one spouse’s sole and separate property. But this does not necessarily mean the spouse who signs the disclaimer deed has absolutely no interest in the value of the property. Most real estate, particularly residential real estate, is acquired subject to a mortgage. If the mortgage is paid with community funds, including income from either spouse’s employment, the disclaiming spouse may be entitled to a portion of the equity gained.
Calculate the Community Lien
There are a few different formulae family courts apply to calculate community liens depending on when the property was acquired and whether it appreciated or depreciated before or during the marriage. For property acquired before the marriage, the family court should consider any premarital change to the property value as part of the owning spouse’s separate property interest.
All of the formulae derive from a seminal case called Drahos v. Rens, where the Arizona Court of Appeals first established the “value-at-dissolution” formula to calculate a community lien. The formula is expressed algebraically as:
C + [ (C / B) x A ]
C = Contributions to Principal
B = Purchase Price
A = Appreciation
Under this equation, the community is entitled to the total principal contributions plus its proportion of the purchase price multiplied by any appreciation during the marriage. The math can be confusing, even to family law attorneys, particularly those with little experience in property division. Essentially, the community is entitled to the principal of its investment in the property plus the proportionate share of the resulting equity.
It also should be noted that principal does not strictly refer to the principal of the loan paid with community funds. It also can include improvements or renovations made with community funds (or labor) that provably improved the market value of the property.
Let’s use a more concrete example to see how the formula is applied. Imagine that a married couple purchases a home for $500,000 and the lender requires the wife to sign a disclaimer deed so that the husband can qualify for superior financing terms. The purchase price, $500,000.00, will be used for the “B” input. Next, let’s assume the parties pay $100,000.00 toward the principal of the loan between their down payment and mortgage payments made during the mortgage. That figure represents the “C” variable. Lastly, let’s imagine the value of the home appreciated to $550,000 during the marriage. The resulting appreciation ($550,000 value – $500,000 purchase price) is $50,000.00 which will our “A” input.
Using these figures, we calculate the community lien as $100,000 + [ ($100,000 / $500,000) x $50,000 ]. Remembering our order of operations, we start inside the parenthetical and $100,000 divided by $500,000 is 0.2. That represents the community’s share or percentage of the appreciation. 0.2 or 20% of $50,000 is $10,000, and we add that to the principal contributions to calculate the community’s interest at $110,000.
Now, that figure represents the community’s interest which presumptively will be divided equally between the spouses. This means if this hypothetical couple divorced or legally separated, the wife would presumptively receive $55,000 as her interest in the property.
Not all community liens are this simple. There may be additional factors for the court to consider, particularly if the property was acquired before the marriage. In those cases, the court should factor premarital appreciation or depreciation pursuant to the modified formula used in Barnett v. Jedynak.
As a brief background, that case involved the husband purchased a few years before the parties married. After the family court ordered the parties to equally divide the equity, the husband filed a motion to amend the judgment to account for premarital appreciation and the wife ultimately appealed. The Court of Appeals modified the Drahos formula slightly to include premarital appreciation by substituting the home’s value on the date of marriage as the “B” variable replacing the purchase price.
Using our previous example, let’s assume our hypothetical husband had purchased the same property before the marriage at the same $500,000 purchase price, but the property appreciated to $525,000 before the parties married. If we use the same $100,000 of principal contributions and the same final appreciation to $550,000, the community’s interest changes from $110,000 to $104,761.90 (represented algebraically as $100,000 + [ ($100,000 / $525,000) x $25,000 ]).
Still, some community liens involve even more complex facts, like disputes regarding the source of funds or the value of improvements. This is an area of Arizona family law where it is especially valuable to speak with an attorney. You can always contact our experienced divorce attorneys for a free consultation.
Depreciation During Marriage
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.