Arizona Complex Community Property Issues

Complex Property Lawyers

At Bishop, Del Vecchio & Beeks Law Office, P.C., our divorce attorneys in Phoenix help people dealing with complex property issues and are available to answer questions from our clients throughout the divorce process. Our Phoenix property division lawyers also represent people in cases requiring enforcement of decrees for the division of property, debt and/or other assets, when an ex-spouse disobeys the Court’s decree – sometimes enforceable through “contempt proceedings.”

Summary of Content

Types of Property

Community Property and Equitable Division

In Arizona, all property acquired during the marriage, including  from the parties’ incomes and efforts,  is presumed to be  “community property.” Community property generally includes financial accounts, investments, retirement and pension accounts, houses, land, business interests, tangible items such as furniture and other items and interests that have value.

As a general rule, community property is divided between the parties equally in an Arizona divorce case, although there are some exceptions. For example, if one of the parties lost or destroyed (gambling, drugs, etc.) community property, or hid community property, the Court may award the other party more property. This is generally done by making a “waste claim.”  The language used in the Arizona statutes requires an “equitable” division of community property. The Courts presume that this means equally, however, in certain cases one party may be awarded additional community property if equity requires an uneven division – this is somewhat rare and requires fairly strong equitable positions. The fact that one party earns more money than the other is not one of the recognized equitable considerations in dividing property. An unequal amount of income between the spouses may be a basis for a spousal maintenance award which is addressed in the spousal maintenance portion of our website. Click here to review our spousal maintenance discussion.

Sole & Separate Property

In Arizona, property acquired prior to marriage, through inheritance, and/or from gifts, is presumed to be that person’s sole and separate property and is not divided. However, in some instances, the property’s nature as sole and separate may be changed or transmuted. For example, if a party deposits sole and separate funds to a community account and such funds were co-mingled or spent, such would be presumed to have become community property. On the other hand, if co-mingled sole and separate funds can be explicitly traced to their source, they may retain their nature as sole and separate property.

Another example where sole and separate property may be converted to community property is where a party has a house in their own name prior to marriage but later places the house in both parties’ names. In such event, the house is generally presumed to have become community property. There are always exceptions to these general rules. Our community property attorneys in Phoenix suggest that you always consult with a property division lawyer regarding your specific circumstances.

There may be a number of financial issues regarding your specific circumstances. For example, retirement accounts and pension benefits may be partially community property and partially separate property depending upon when the contributions were made.  Non-vested property interests may also be subject to division. For example, a spouse is entitled to receive his or her community share of non-vested retirement and pension benefits, stock options and other employment benefits in the future if the benefits eventually vest.

If a spouse or both spouses own a business, such business may need to be valued. Some of the business value may have been acquired prior to marriage, and some of the interests accrued after marriage. A more detailed discussion of business interests in divorce cases is set forth under “Complex Property Issues,” below.

Types of Debts

Community Debts

As a general rule, debts incurred during a marriage will be divided equally; however, there are exceptions to this presumption. Debts incurred during the marriage are presumed to be community debts even if only one of the spouses incurred such debts, even if such debt is only in one spouse’s name, and even if the other party did not know about such debt. However, the Court does have the discretion in some cases to split the debt unevenly. Similar to the division of property, the Arizona Revised Statutes require an equitable division of community debts between the parties. The Courts presume that such division is equal, however, equitable principles may require an unequal division. For example, the Court may require a party to pay his or her own student loans under equitable principles even though the loans were acquired during the marriage.

Sole & Separate Debts

Debts incurred prior to marriage are the responsibility of the person incurring such debts. Debts incurred after a divorce proceeding is filed and served is generally the responsibility of the person incurring such debts. However, certain precautions should be made, as you may still be responsible for such debts to the creditors.

There may be reimbursement issues if marital assets were used to pay pre-marriage sole and separate debts, and pursuant to various other situations.

Note: These are issues that you should always discuss with a trusted family law lawyer in one or our Phoenix or Tempe office locations. During your consultation, our law firm will provide you with its opinions or approach regarding your community property, separate property, and debts incurred during your marriage.

Complex Property Division

As noted above, the starting principles of Arizona community property law provide that property acquired prior to marriage, or by gift or inheritance, constitutes sole and separate property, and presumes that property acquired during marriage constitutes community property. However, such may be convoluted by a parties’ actions, such as joint titling real estate, commingling funds (i.e. the mixing of separate and community funds), using community funds to pay sole and separate property obligations, and with regard to increases in the value of separate  property such as a business during marriage which was caused in part by the labor or management of one or both of the parties.

In some cases, a property may be owned as separate property but increases in value or equity during marriage. The most common examples are separate property businesses and separate property real estate interests.  In some cases the “community” may have a claim to at least a portion of the increase in value or increase in equity in the separate property based upon efforts (community labor) made by one or both parties or financial contributions made by one or both parties that benefited such interests.

What if I Owned a Home or Other Real Estate Prior to Marriage or Inherited it During Marriage?

What if There Is A Disclaimer Deed?

If a party owned a home prior to marriage or inherited a home (or other real estate) such constitutes his or her sole and separate property so long as he or she did not add the other spouse to title.  However, if the community made capital contributions by paying the mortgage (even if from one party’s income during marriage) or paid for improvements to the home, the community may have a claim to a portion of the equity in the home or other real estate. Such is more than just a reimbursement claim as the community would be entitled to its proportionate share of the increase in value or equity.  This is often called a Drahos analysis (named after one of the cases that addressed such issues).

Sometimes a home is purchased during the marriage and the other party signs a disclaimer deed. Even though the other party signed a disclaimer deed, the property may in some instances still be community property or in the alternative the community may have an equitable lien (i.e. a share of the equity).

William Bishop of our firm wrote an article regarding these technical concepts for continuing legal education programs he teaches to other lawyers in the state. To see the full version of the article click here.

What if We Started a Business During Marriage?

One of the more complex areas of divorce law regards business valuation issues. It is possible that the business may have value to the parties which exceed the value of the hard assets themselves. The value of a business above and beyond its hard assets is called “goodwill.” This is sometimes referred to in the industry as “blue sky value.” In some states, only businesses which are capable of being sold have a value above and beyond the value of the hard assets. This is often referred to as “enterprise goodwill.” However, in Arizona, a business may have goodwill value even if it is not capable of being sold. Arizona recognizes what is sometimes called “professional goodwill.” In Arizona, “goodwill” has been defined as “that asset, intangible in form, which is an element responsible for profits in a business.” Such has also been defined in a narrow sense as “a probability of repeat customers,” and in its broadest sense as “reputation.” Mitchell v. Mitchell, 152 Ariz. 317, 319, 732 P.2d 208 (Ariz. 1987). To view a further explanation of Arizona case law regarding goodwill in Arizona, click here.

In some cases, it is clear that only one of the spouses can continue to operate the business. In such event, it is clear what party will receive the business. Thus, the issue is how much the other party should be compensated for his or her interests in the business. In some cases, both of the parties have the ability to operate the business. In such event, the highest bidder between the partners may receive the business. In some cases where the parties  cannot agree it is always possible that the Court could order the sale of a community business that was started during marriage.

If a business was started prior to marriage and ownership of the company has not been changed to add the other spouse, it is presumed that such business remains the sole and separate property of the spouse. We have addressed potential community claims regarding any increase in value to the business during marriage below.

Valuation of Businesses in Arizona

There are numerous methods of valuing a business. A good business valuation expert will generally address all of the major methods, and then make a recommendation to the Court regarding the method most appropriate under the circumstances. A few of such methods are addressed in this section.

Rule of Thumb Method

Pursuant to a rule of thumb method, the ‘expert’ uses an industry standard multiple which is often applied to either gross revenues or business profits (for example 2 times annual gross revenues). Such method is consistently criticized by most certified business valuation experts experts as most businesses are very much different from one another, and various factors are not considered in such a simplistic valuation.

Book Value

Pursuant to the book value method, the value of the business is limited to its hard assets – i.e. equipment, inventory, cash accounts, accounts receivables, etc. Such a method does not take into account goodwill and has a fairly limited purpose. Such a method may be appropriate if the profits of the company (or the income to the owner) does not exceed what the owner would make as an employee of another company.

Fair Market Value

Pursuant to fair market valuation, a company is valued at what a hypothetical willing buyer would pay a hypothetical willing seller under normal market conditions without undue duress. Such a method may be appropriate where a business is capable of being sold. The business valuation expert will generally apply marketability discounts and minority interest discounts when appropriate.

Fair Value

Fair value is arguably most appropriate in valuing businesses which may not marketable to third parties. Such may include professional practices such as law offices or other businesses which require the owner to continue in the business in order for the business to succeed. Pursuant to the fair value method, the expert determines the inherent value to the owner as opposed to the value to a hypothetical third party. In determining such value, the expert applies a ‘capitalization of earnings’ approach. Simplistically stated, the expert compares the owner’s income and benefits to what an employee of a company with similar experience would receive (i.e. an “income method” of valuation). The excess income and benefits are then capitalized to determine the goodwill value of the business.

Experts often argue over whether a minority or marketability discount should apply where other persons have ownership interests, where a business is not being marketed for sale or is not capable of sale. The fair value of the business generally substantially exceeds the fair market value of the business in light of the lack of marketability and minority discounts.

Use of Experts in Valuation Cases.

We have found that expert opinions regarding the value of the business may vary greatly. Sometimes the parties agree upon an expert, and only one valuation is conducted. In other cases, the parties may each retain their own expert. In such cases, the Court makes the decision regarding the value of the business based, in part, upon the factors presented by each expert. The Court may decide that one expert is more credible than the other expert and adopt one of the opinions, or may come to its own conclusions which could be somewhat different than both experts’ opinions.

It is important to retain an attorney that has superior knowledge and experience in business valuations. There are a number subjective factors that an expert may not get right, which can dramatically affect the final valuation amount. A family law attorney with such knowledge will know how to best persuade the expert (and Court) to address such subjective factors.

Business Started Before Marriage, But Increased in Value During Marriage

Although a business started before marriage is technically sole and separate property, the community “may” have a claim to a portion of the increase in value which took place during the marriage.

This is one of the most complex areas of divorce litigation. There are a number of published cases from Arizona which deal with such issues. The main cases in Arizona are Rueschenberg v. Rueschenberg, and Cockrill v. Cockrill.

The complexity of these types of  cases is exacerbated by the fact that the expert must first perform two valuations, i.e. the value of the company at the time of marriage, and the increased value of the company during the marriage. This may be complicated by the various valuation approaches and whether more than one expert is involved.

There are then various methods in which to apportion the increase in the value of the company between the community and the sole and separate interests. The basic concept is that the community should receive its share of the growth in the company which is attributable to community efforts and management, and the party that owned the business prior to marriage should receive a return on his or her investment including the portion of the growth which is attributable to inherent factors associated with the pre-marriage attributes of the company  (i.e. factors other than community efforts and ongoing management).

The Rueschenberg Court also addressed that the community may have already been adequately compensated for its interests in the increased value of the business pursuant to the income received by the community during the marriage. Thus, even if part of the increase in the value of the company is due to community efforts, it could be determined that the income already received during the marriage satisfied the community’s interests in the increased value, and thus the community would not be entitled to further compensation. This may apply where the business was already successful at the time of marriage and the community received company profits that flowed from the pre-marriage characteristics of the business.

The case law at this time is very complex, and there are different interpretations of the various factors which can be argued. It is extremely important to retain an attorney well versed in such issues if such are present in your divorce. Contact an experienced attorney today online or via phone at (602) 749-8500.

William D. Bishop, of Bishop Law Offices, P.C., has substantial experience with valuation issues and cases involving separate property businesses and community lien claims. Mr. Bishop wrote an in-depth article regarding business valuation and apportionment issues titled, “A Long and Winding Road – Untangling the Knots In Business Valuation and Apportionment Issues.” You may review the article for a very detailed analysis of sole and separate business interests and community claims to increased value by clicking here.

What happens to the profits from a community business or separate property business during divorce proceedings?

Bill Bishop wrote a recent article for the 2021 State Bar of Arizona / AAML legal education program regarding this issue. Click here to review the article.

Co-mingling Issues and Tracing Issues in Arizona Divorce Cases

The concept of co-mingling comes up when sole and separate property funds are mixed in the same account with community property funds. As of 2020, Arizona law regarding such concepts is still in work in progress.

As noted previously, property (including money) owned prior to marriage continues to be a spouse’s sole and separate property. However, certain actions can mess up a spouse’s ability to claim such money as sole and separate property such as the co-mingling of sole and separate and community funds. Keep in mind that money “earned” during marriage is considered community funds even if earned solely by one of the spouses. There are instances that money received during marriage ‘may’ be sole and separate property (i.e. such as inheritance or proceeds received from sources owned prior to marriage).

One of the more complex property issues we see in divorce cases in Arizona regards the co-mingling of money and whether co-mingled monies are considered community property, sole and separate property or whether they are part community property and part sole and separate property.

Co-mingling may happen when a spouse’s community property paychecks are deposited into an account that the spouse had before marriage (i.e. thus combining pre-marriage funds with funds earned during marriage). This may also happen when a spouse sells sole and separate property and then deposits the proceeds into a community account.

If sole and separate and community funds are co-mingled, the entire balance of the account is “presumed” to be community property. However, this presumption can be rebutted in certain situations. For example, if the amount of community funds co-mingled with separate funds is very small, Arizona cases have held that they can be separated out. Another example is where money went in and out of an account contemporaneously – For example, Wife transferred $50,000 of her sole and separate property into the joint community checking account and then two weeks later transferred out the $50,000 for a designated purchase. Such shows that Wife intended to use the checking account as a “landing spot” so that she could more easily transfer funds as opposed to such being considered a “gift” to the community.

The most common terminology used when rebutting the presumption is the concept of “tracing”. Arizona has adopted the requirement that a party must directly trace or explicitly trace his / her sole and separate transactions in order to prove that a portion of a co-mingled account is sole and separate property. Arizona case law has not fully defined what direct tracing or explicit tracing means in a published case law opinion. Unpublished Arizona opinions on the issue set the bar high, i.e. one must be able to identify and separate the exact dollars as opposed to other accounting theories. This is more easy to establish where the money went in and out of an account or where there is only a very small amount of community property inadvertently mixed in. This is also more easy to establish where the only comingling regards deposits and no withdrawals have been made. Where it becomes difficult or impossible to directly trace is where numerous withdrawals, payments and deposits took place between the time periods involving the commingling of community and separate funds. Under a strict direct tracing analysis, the Court cannot assume that payments out were for community purposes as opposed to sole and separate purposes. In unpublished opinions, the Arizona Court of Appeals has rejected alternate theories such as the ‘sinking fund theory’. This is when a party argues that the Court can presume that certain payments are for community purposes and that the sole and separate funds somehow sunk to the bottom of the account. Such means that the Court would have to presume that community funds were used for community purposes and that the sole and separate funds should be segregated. Again, such concept has not been adopted in any published court opinions and has been rejected in unpublished opinions. Another accounting method is the pro-rata theory – i.e. that the Court should divide the account by the percentage of community funds versus sole and separate funds deposited into the account. Like the sinking fund theory, the pro-rata theory has not been adopted in any published opinions and has been rejected in unpublished opinions.

(Published case opinions are those opinions that may be cited as legal precedent. Unpublished case opinions may not be cited as legal precedent and may only be cited under narrow circumstances.)

Because the direct tracing / explicit tracing concepts have not been fully developed in published case law decisions, there is some flexibility when making arguments that funds can be traced. However, unless you have a situation where money went in and out without a lot of interim activity, or money is earmarked for a specific sole and separate transaction, or few or no withdrawals or transactions were made in the meantime, the chances of rebutting the community property presumption are problematic.

Where extensive co-mingling has taken place and the ability to trace is not obvious, CPAs are generally retained to provide a tracing analysis.

Types of co-mingling that tracing usually is usually not necessary includes retirement accounts and other accounts where very little transactions take place. In such instances, the expert can generally calculate the sole and separate deposits versus the community deposits and the gains or losses against each.

If you have co-mingling issues, it is highly recommended that you retain a divorce attorney that has substantial experience.