Arizona Complex Community Property Issues

Arizona High Asset And Complex Property Lawyers

At Bishop, Del Vecchio & Beeks Law Office, P.C., our divorce attorneys in Phoenix help people dealing with high asset and complex property issues, and are available to provide expert guidance and answer questions from our clients throughout the divorce process. If you and your spouse have substantial wealth, it is likely that you will have complex issues involving the division of your assets and debts. This is even more true if there is a business involved. In these cases, it is important to have a divorce and family law specialist in your corner.

The following is a more in-depth discussion of complex issues involving community and separate property assets and debts pursuant to Arizona law.  If you want to first read the basics involving community property and debts, please check out our “Community Property and Debt – The Basics” portion of our website by clicking here.

In the following sections we will address more advanced and in-depth topics including separate and community property businesses, circumstances where a spouse may request an unequal division of community property or community debts, reimbursements and offsets, community liens where community funds or community efforts benefit separate property, and various other issues that may arise in your case.

1. What Are the Types of Property Divided During Divorce

Basically anything of value acquired during the marriage is presumed to constitute community property and divided equally upon divorce or legal separation.

To begin with, there are two general types of property categories under Arizona law.

“Real property” means all real estate, including the marital home, rental properties, investment properties, bare land, commercial real estate, and other forms of real estate.

The other category is called “Personal Property”, which essentially means any other assets that are not real estate. People often think of “Personal Property” as just meaning tangible items one can find in their home. However, in a legal context, “Personal Property” means everything that is not real estate. It is important in a divorce context that we identify all of the property that may be subject to division in your case. For purposes of our discussion, “Personal Property” includes but is not limited to the following:

• Bank accounts
• Investment accounts (stocks, bonds, treasuries, etc.)
• Retirement accounts (IRAs, 401K accounts, 403b accounts, pensions etc.)
• Annuities
• Employment based stock options, restricted stock units etc.
• Employment bonuses not yet received if earned in part during marriage
• Insurance policies (cash value, etc.)
• Promissory notes (money owed to you or your company)
• Business interests
• Home furnishings
• Collectibles
• Tools and equipment

Some of these property interests may be personally owned, and some may be in the name of a trust, a business or other entity. We help you ensure that all community property assets are accounted for.

2. How is Community Property Divided in a Divorce?

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

The Arizona statute regarding the division of community property states that all such property shall be divided “equitable”. 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 spent community funds inappropriately (excessive gambling, drugs, etc.), or improperly transferred or hid community funds, the Court may award the other party more property to make up for this. The language used in the Arizona statutes requires an “equitable” division of community property. The Courts presume that this means equal, however, in certain cases one party may be awarded additional community property if equity requires an uneven division. We have discussed circumstances that may warrant an unequal division of community property later on this page of our website.

In making the division by agreement or by Court decision, sometimes one of the spouses receives certain assets and the other spouse receives certain assets. These may be assets that cannot be divided in half such as a home or business. Community property financial accounts and investments are generally divided equally (this allows for each of the parties’ to receive the same tax basic and tax treatment for their respective shares). The community portion of retirement accounts are generally divided equally by offsetting each spouse’s own retirement accounts and providing for a rollover or transfer of the difference. Sometimes an equalization amount is ordered so that the spouse that receives more property pays the other spouse the difference so that each party receives equal amounts (this often happens where one of the spouses buys the other one out of a community property business).

Where possible, we always try to accomplish an equitable and fair settlement of these issues  between the spouses so that we can ensure the division is equitable, that tax consequences are taken into account, and so that any other significant issues can be factored.

3. What Happens To Our  House in A Divorce?

Is my marital residence community property? If the property is titled in both spouse’s names it is presumed to be community property regardless of when it was purchased, and regardless if either party spent their separate funds purchasing or improving the property.

The marital residence, if it is community property ,is often the most valuable community asset to be factored. Here are some potential ways to divide the home and make sure each party receives their share.

1. Sell the home and divide the net assets equally.
2. One party buys the other party’s 1/2 equity in the home. This generally requires the purchasing spouse to refinance the underlying mortgage so that the other spouse is no longer liable.
3. In some cases, the Parties agree to continue to co-own the property until a certain point in time (such as the children graduating high school). Any such agreement needs to include details such as who will pay the mortgage and home expenses in the meantime.

If one spouse is going to buy out the other, the value of the home will need to be determined. This can be done by appraisal or by agreement between the parties as to value. Some people are fine with a Zillow value, but this is not always the best way to calculate value. The other party’s share would then be one-half of the value minus encumbrances (i.e., mortgages).

If the home is one of the parties’ separate property, we address the potential community lien interests associated with community contributions later in this article.

4. How are Retirement Assets Divided?

The basic premise is that the community portion of any retirement assets is divided equally, and the separate property portion acquired prior to marriage (and any gains on such portion) is not divided.

There are two general types of retirement plans. The first type is called a “defined contribution plan”. The second type is called a “defined benefit plan”.

Defined contribution plans are retirement accounts that have a specific balance. Upon retirement, a party can access these specific funds until they are all gone.

Defined benefit plans are retirement plans that pay a specific amount every month until the recipient dies. There is no specific total, but rather a monthly payout. The longer the participant lives, the more money they receive during retirement. These plans are like an annuity. These plans may have survivor benefits for the other spouse that kick in when the participant dies.

     A. Defined Contribution Plans

Most retirement accounts these days are defined contribution plans. This includes but is not limited to 401K accounts, 403b accounts, IRAs, Arizona State Retirement Accounts, and other qualified retirement accounts that have a specific balance that you can draw against upon retirement. Because there is a specific amount in these plans, funds that are not taken prior to death can be left to beneficiaries.

Simple IRAs can be easily divided with any difference in amounts between the parties rolled over so that each party receives an equal amount of the community portion (i.e., those IRAs and balances obtained during the marriage). This can usually be accomplished through your financial advisor. Of course different types of IRAs may be divided in a different manner. For example, a simple IRA is tax deferred and thus treated differently than an Roth IRA where the parties pay the taxes up front. Thus, you cannot do a simple offset between these types of IRAs. In such event, each IRA can be divided equally so that each party receives their fair share of taxable and non-taxable portions.

Federal defined contribution plans such as 401Ks and 403bs are subject to ERISA (Employee Retirement Income Security Act of 1974). These are employment retirement funds in which generally both the employer and employee contribute toward. These are qualified contribution accounts that have a specific balance of funds available (i.e., a defined contribution plan). The division of these types of accounts requires a special order called a Qualified Domestic Relations Order (QDRO). Sometimes the expert can offset various retirement accounts against each other so that there are not as many divisions if each spouse can receive the same amount of community retirement funds as an end result.

     B. Defined Benefit Plans

A defined benefit plan does not have an account balance per se. Rather this is a benefit where the participant is entitled to a specific periodic payment upon retirement (usually paid monthly). These are often “pension plans”. Large corporations used to provide these types of plans, but they have dried up over the years. However, we still see quite a few of these plans for government and military personnel.

For the most part, these types of defined benefit plans can generally be divided with each spouse entitled to an equal amount of the community portion of the monthly payout. The separate property portion (i.e. accrued prior to or after marriage) would only be provided to the employee participant. Federal plans are divided by a Qualified Domestic Relations Order. State plans are divided similarly by a Domestic Relations Order. These types of orders are complex and must follow federal or state guidelines.

There also may be survivor benefits available under these plans. This often involves contested issues regarding whether to choose or continue such survivor benefits as these are generally paid for through a reduction in the monthly benefit.

Pensions and other defined benefit plans give rise to very complex issues. Military defined benefit plans are different than government plans. Private company plans can be different than both of these.

Thus it is imperative that an expert draft such orders. Our firm associates with retirement plan experts that can do this at a very reasonable cost.

     C. What if Certain Pension or Other Benefits Have Not Fully Vested? 

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. The Court order should thus provide that if and when such benefits vest, the community is entitled to the share that was acquired during the marriage, and the owner spouse retains the pro-rata share of such benefits acquired afterward.

5. Community Interests in Employment Benefits

Employment benefits earned during the marriage but not yet received are community property and subject to division.

A main example is a bonus that was earned at least in part during the marriage, but not receive until after service of the petition for divorce or legal separation. In such event, the bonus is generally pro-rated based upon the portion earned during marriage and the portion earned after service of process of the petition for divorce or legal separation. For example, if a bonus is based upon the calendar year and service of the divorce was made on June 30th (i.e., the 1/2 point during the calendar year), the community would be entitled to 50% of the bonus (i.e., 25% to the non employee spouse), and the employed spouse would receive the other 50% as their separate property (i.e., 75% of the net total). Of course the taxes on such bonus would have to be factored prior to division.

Other types of employment benefits and/or income which may be subject to division include accrued vacation time (if such can be cashed out), Health Savings Accounts, stock options, restricted stock units, executive key employee incentive pay, and various other benefits attributable to the period of marriage, but not yet received.

As set forth in the preceding section, Arizona law holds that the community is entitled to receive employee benefits that vest over time but have not yet paid out where part of the time period covered was during the marriage. In such event, the final Court orders (or final agreement between the parties) generally provide a percentage formula based upon the time of marriage versus the non-marital time period. Of course the community only receives its pro-rata portion if and when the benefit eventually vests. If the employee does not vest (i.e., the employee resigns or is terminated from employment), than of course the community does not receive a benefit that does not vest.

6. Division of Other Personal Property

Division of community financial accounts is generally fairly easy as such is based upon account balances. This is generally the account balances as of the date of service of the petition for divorce (subject to possible offsets as addressed later in this discussion).

Division of community tangible items such as furnishings, artwork, tools, etc. is generally based upon value. In most cases, people can agree between themselves how to divide such items. In rare cases an appraisal may be necessary to determine the values to be used in the division.

7. What if I do not Understand What We Have in Assets?

There are many cases where one spouse left it to the other spouse to handle the parties’ financial affairs. In such cases, a spouse may not have knowledge of the extent of community property that the parties have acquired. If the parties own a business, this may be even more confusing and complex.

Our firm has substantial knowledge and experience in obtaining the information and documentation necessary to ensure that we have identified all community assets and that they are fairly divided between the parties.

8. If My Spouse Makes More Income Than Me Will I Receive More  Property?

Pursuant to Arizona community property law, the fact that one party earns more money than the other is not one of the recognized equitable considerations in dividing community 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.

9. 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. The separate property owner is also entitled to any gains in value or profits from their separate property that did not require their “community efforts” to acquire (community efforts mean the efforts by either spouse during the marriage). If a spouse commits community efforts or community funds that increase the equity, value or profits of their separate property, this does not convert the property to community property. However, in some instances, the community may be entitled to reimbursement and/or a community lien. This is discussed in more detail below.

10. Can Separate Property Be Converted to Community Property?

     A. Commingling (mixing) of community and separate property funds:

In some instances, monies that were initially sole and separate may be changed or transmuted into community property through comingling. For example, if a party deposits or transfers sole and separate funds to a community account, or community funds to a separate account, and such funds were co-mingled, the entire remaining balance is  presumed to have become community property. On the other hand, if the account did not have a lot of activity and co-mingled sole and separate funds can still be explicitly traced to their source, they may retain their nature as sole and separate property. There are other exceptions to the comingling rule. If separate funds were in the community account for a short time before they were transferred out, one may be able to show that it was not his/her intent that the funds become community.  Another possible exception is if there are only a small amount of community funds in the account that were comingled. This is called the “de-minimus” exception.

We address co-mingling issues in further detail later in this article.

     B. Converting Separate Property Real Estate to Community Property By Changing the Deed.

Another example where sole and separate property may be converted to community property is where a party has a house or other real estate in their own name but later places the house in both parties’ names. In such event, the house is generally presumed to have become community property (Arizona case law states that this is a presumed gift from the separate property owner to the community).  This is often done when a spouse wants to refinance the loan.  In such event, the title company or lender may tell you that the loan (and therefore title) needs to be in both names because you are married. This is incorrect advise, however, many separate property real estate owners through the years have made this mistake.

There may be some exceptions to these general rules. Our community property attorneys in Phoenix suggest that you always consult with a divorce / property division lawyer regarding your specific circumstances.

     C. Placing a Separate Property Financial Account in Both Parties’ Names.

The presumption that applies to real estate does not apply to financial accounts and other personal property. If a person adds his or her spouse to a separate property financial account for example, it does not convert the financial account to community property unless the non-owner spouse can prove by “clear and convincing evidence” that the owner spouse intended that the account become community property. This is different than co-mingling assuming that the original separate property funds were not mixed with community funds (such as income received during marriage).

11. Mixed Property – Partially Community and Partially Separate

Some assets can be mixed – i.e. partially community property and partially separate property. A notable example of this is a retirement account. Often people have a retirement account or benefit that started prior to marriage, but had community funds added during the marriage. In such a case, the portion earned prior to marriage and any gains / losses on that amount would be separate property, and the amount added during marriage and any gains on losses on that amount would be community property. If both parties have retirement accounts, they can usually offset the accounts against one another with an equalizing roll-over to a spouse’s retirement account to equalize the difference in values. With regard to qualified retirement accounts, such as 401K and 403B accounts, the parties will often hire an expert who can draft a Qualified Domestic Relations Order or other type of order to provide for such equalization or division. Your family law attorney will usually set this up for you.

It should be noted that although certain retirement accounts  contain both pre-marriage contributions and contributions during marriage, and thus contain “co-mingled funds”, such are easily traceable because such accounts are not subject to the constant deposits, transfers and withdrawals that regular financial accounts may incur.

Other examples of “mixed” property (i.e. partially sole and partially community) may be employment bonuses and commissions as previously discussed. Sometimes a party receives funds as a result of efforts spent prior to the divorce being served, and additional efforts afterward. In such case, a bonus or commission may have to be divided pro-rata depending upon what was earned or contributed prior to and after the service of a divorce or legal separation.   Another example is real estate commissions received after service of a divorce petition, but which the spouse also provided efforts prior to the divorce petition. In such case, the Court would look to the efforts by the real estate agent spouse before service of the divorce documents versus her / her efforts afterward, and pro-rate the commission between the community and the separate portion accordingly. We often see the situation as applied to law firms and other businesses where work was done for clients before the divorce was filed, but the income was not received until later.

12. Types of Debts

Debts may be in many forms. There are secured debts where the asset is directly encumbered by the debt such as a mortgage or automobile lien. In such event, if you do not pay the debt, the lender can foreclose and take the secured property back. Various loans such as business loans may also be secured by certain property, such as the business assets.

Unsecured loans include credit card debt, and sometimes personal loans from third parties.

Many spouses also have tax debts that have incurred over time. These are especially important to address in the divorce as the IRS and Arizona Department of Revenue have more power than normal creditors to seize assets and income if they are not paid. In the event of substantial tax debt, we may include expert tax advisors to assist our clients.

Similar to community property, our firm makes sure that we identify all potential community debts prior to the division of community assets in order to make sure there are no unfortunate surprises after divorce.

13. What Constitutes Community Debts and How Are They Divided

As a general rule, debts incurred during a marriage constitute community debts and will be divided equally. 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 spouse 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 should be equal, however, equitable principles and unique facts in some cases 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. Such equitable principles that may lead to an unequal division of property and/or debts is discussed in more detail later in this article.

Specific community debts may be divided equally pursuant to an agreement or divorce order (for example each party is ordered to pay 50% of a specific credit card debt). However, more often one of the spouses is assigned certain debts and the other spouse assigned certain debts. Debts may also be offset against assets – for example, a party who receives more assets may take on more offsetting debt in order to equalize the final amounts so that the overall balance is equal. Sometimes the parties are able to pay all of the community debts before the community assets are divided.

Secured debts (those associated with specific assets) are generally assumed by the party receiving the asset. The value of the asset used for purposes of the final division between the parties is generally the value minus the debt.  In some cases though (such as the marital home), the party keeping the asset will need to refinance the underlying loan in order to remove the other party from further liability.

14. Sole & Separate Debts

As set forth above, the general rule is that only the debts incurred during the marriage are community 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 the responsibility of the person incurring such debts. However, certain precautions should be made, as you may still be responsible for such post-service debts to the creditors if you are jointly liable on the underlying contract (such as a joint credit card) and do not notify the creditor of your divorce proceedings.

There may be reimbursement issues if marital assets were used to pay pre-marriage sole and separate debts, and pursuant to various other situations. This is addressed in more detail later in this article.

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 and recommended approach regarding your community property, separate property, and debts incurred during your marriage.

15. 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, or the use of community funds.

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 during marriage that benefited such interests.

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

As stated above, such real estate (so long as not later titled in both parties’ names) constitutes the owner’s sole and separate property. However, the community may have a claim to some of the equity as described further below.

17. What is a Community Lien on Separate Property Real Estate?

If a party owned a home prior to marriage or later 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. A party may also acquire separate property real estate during the marriage where the other spouse signs a disclaimer deed (this is addressed in this next section).

However, even if the real estate is separate property of one of the spouses,  if the community made capital contributions by paying the mortgage (even if only paid 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 may also 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). The community interest is generally called a “community lien”.

18. What If One of the Spouses Signed a Disclaimer Deed to the Home Or Other Real Estate?

Sometimes a home or other real estate is purchased during the marriage and the other party signs a disclaimer deed (disclaiming any interests in the real estate) at the time the real estate was purchased. The general rule is that the home is the purchaser’s separate property even though it was purchased during marriage, and even if community funds were used toward the purchase or mortgage. There may be exceptions to this rule if the disclaimer deed was signed by a spouse due to fraud or a result of mistake.

Similar to the prior section of this article, the Court will generally recognize the community’s capital contributions to the purchase price, mortgage and/or capital improvements through a community lien (reimbursement plus a proportionate share of the increase in value).

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

19. What if We Started a Business During Marriage?

A business that is started during marriage is presumed to constitute community property. Thus, even though only one party runs such business, and even if such business is only in one of the parties’ names, the spouses generally have equal interests in the business under Arizona’s community property laws. In some divorce cases, the business will be sold and the sale proceeds divided equally. However, in most cases the spouse that runs the business will retain the business and will purchase the other spouse’s interests through the division of other assets or secured payments over time.

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 hard assets. However, in Arizona, a business may have goodwill value beyond its assets 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 later in this article.

20. 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.

     A. 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 numerous factors and variables are not considered in such a simplistic valuation.

     B. Book Value (Asset Value)

Pursuant to the book value method (also called Asset Value), the value of the business is limited to its hard assets – i.e. equipment, inventory, cash accounts, accounts receivables, etc. Such method does not take into account goodwill and has a fairly limited purpose. Such 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 with comparable duties. However, more profitable businesses are generally subject to a higher value that exceed its book or asset value.

     C. 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 when using such method will review publications that show what similar businesses in the industry have sold for. The business valuation expert may apply marketability discounts and/or minority interest discounts when appropriate.

     D. Fair Value

Fair value is arguably most appropriate in valuing businesses which may not marketable to third parties, or in which there are few or no sales of record that regard sufficiently similar businesses. Such businesses may include professional practices such as law offices, medical practices,  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 and duties 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. Such depends upon various circumstances such as the owner’s level of control within the business.

21. Use of Experts in Business Valuation Cases.

In most business valuation cases experts are hired to issue opinions as to the businesses’ value. 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 many cases, the parties ultimately agree to the valuation issued by a mutually retained expert. If the parties cannot reach an agreement as to value,  the Court makes the decision regarding the value of the business based, in part, upon the factors presented by one or more experts. 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. These are complex issues that State Bar of Arizona Certified Family Law Experts have shown the requisite knowledge and experience.  There are a number subjective factors that an expert may not get right, or legal principles that an expert does not fully comprehend, which can dramatically affect the final valuation amount. A family law attorney with such advanced knowledge will know how to best persuade the expert (and Court) to properly address such subjective factors.

22. Businesses Started Before Marriage, But Which Increased in Value During Marriage

Although a business started before marriage is the business owner’s sole and separate property, the community “may” have a claim to a portion of the increase in value and undistributed profits 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, Rowe v. Roden, 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. to establish the value of the company at the time of marriage, and the value of the company at the time of the service of the divorce proceedings (or other appropriate end date), in order to determine the increase in value  during the marriage. This may be complicated by the various valuation approaches and whether more than one expert is involved.

The basic principles that are determined in apportioning the increased value (and possibly undistributed profits) between the separate property and community interest is to determine what portion of the increase in value is attributable to the inherent qualities of the business as of the date of marriage or acquisition as separate property versus what portion of the increase in value is a result of community efforts and investment. As noted previously, it does not matter which spouse provides the efforts as both parties’ efforts are deemed community in nature.

There are various methods that have been applied pursuant to Arizona case decisions when apportioning the increase in the value of the company between the community and the sole and separate interests once the beginning and end valuation dates have been determined. These include but are not limited to returning a fair rate of return to the separate property owner with the remainder deemed community property. In the Rueschenberg case, the Court applied a rate of return and then divided the differential between the community and separate property based upon what it deemed as based upon community efforts versus factors outside of community efforts.

The Rueschenberg Court also addressed that the community may have already been adequately compensated for its interests in the increased value of the business as a result of the income received by the community during the marriage. The Court reasoned that if the community receives the separate owner’s inherent share of the income during marriage, this may offset all or a portion of the community’s interest in the increased value of the business. 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 inherent 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 We 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.

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

If the business is community property, the profits during the divorce proceedings may need to be divided in a pro-rata percentage until the business is sold or one of the spouses purchases the other spouse’s interests. The general rule is set forth by an Arizona case called Schnickner v. Schickner. The basic rule is that the spouse that continues to run the business is entitled to reasonable compensation during the divorce proceedings. Any income that in excess of what is determined to be reasonable income is presumed to constitute community property, even though received after the divorce proceedings are commenced. If the owner spouse receives less than or equal to what is determined to be reasonable compensation associated with the spouse’s efforts, than of course there would be no excess profits to distribute to the community.

If the business in one of the spouse’s separate property, however, the income received during the divorce proceedings is more complicated and is not yet fully resolved by the Courts. The non-owner spouse may argue that the community is entitled to a share of any excess post-service income / profits received prior to the satisfaction of the community lien. This is based upon language from case law that a community business lien on a separate property business is an “equity” claim. Such a claim for a portion of the profits, however, would not only would exclude the owner-operator’s reasonable income from post-service efforts, but any income flowing from the inherent nature of the separate property business. Conversely, the separate property owner could argue that published case law to date has only granted a portion of post-service profits where a community business was at issue, and that any community efforts would cease when the divorce proceedings were filed and served.

As you can see these are very complex financial issues that can have a significant impact upon what a spouse will have to pay or what a spouse may receive as a result of divorce proceedings. In the event that you have a community or separate property business at stake, it is important to hire a divorce and family law firm with substantial experience with these issues.

Bill Bishop is known as one of the foremost attorney experts regarding these issues. Mr. Bishop wrote a more detailed article for the State Bar of Arizona / AAML continuing legal education program regarding these issues. His article is published on the American Academy of Matrimonial Lawyers (Arizona Chapter) website at azaaml.org.  Click here to review the article.

24. Co-mingling and Tracing Issues in Arizona Divorce Cases (Continued …).

We addressed co-mingling issues in a more basic format earlier in this article. However, if you have co-mingling issues in your case, you may be interested in learning more details on how the law works. As set forth earlier, 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 2024, Arizona law regarding such issues 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, dividends and rents received from separate property sources).

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. We also see this happen when a spouse inherits money (which would be their separate property), but then deposits the funds into an account which contains community funds.

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 funds and 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 are somewhat inconsistent. Some cases set the bar high, i.e. one must be able to prove that the exact dollars still exist 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. Such flexibility was shown in a more recent case decision called Chauncey v. Chauncey, which was issued by the Arizona Court of Appeals. 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 that few or no withdrawals or transactions were made in the meantime, the chances of rebutting the community property presumption can be challenging.

Types of co-mingling that tracing usually is not necessary includes retirement accounts and other accounts where very little or no transactions take place other than deposits. In such instances, the expert can generally calculate the sole and separate deposits versus the community deposits and the gains or losses attributable to each.

Where extensive co-mingling has taken place and the ability to trace is not obvious, CPAs are generally retained by your attorney to provide a tracing analysis. In cases where there is a lot of money at issue, it is important to have a very experienced family law specialist in your corner.

25. Waste / Improper Use of Community Assets

Arizona recognizes “waste claims” regarding the improper use of community funds or assets during the marriage.

Although either party during marriage may spend community funds without broad discretion, there are certain instances that a Court may require a party to pay back funds that were wasted or improperly diverted. This “waste” concept is somewhat limited to expenditures that were clearly not in the community interests. Such may include excessive gambling, money spent on illegal drugs during the marriage, extra marital affairs, or other expenditures that the Court deems excessive and/or wasteful, or that clearly only served one of the parties’ interests.  On the other hand, the Court generally does not find bad investments as waste as such are generally intended to benefit the community, even though the investment did not work out in the end.

The Court may also hold a party responsible for missing funds. If a spouse can show that the other spouse took funds that cannot be accounted for, the party who controlled such funds generally must show what the funds were used for. If he / she is unable to do so, the Court may require the spouse that controlled the funds to repay such funds from their share of other assets.

It is important that you have a good attorney if you are making a waste claim, or if your spouse is making a waste claim against you. There are no short-cuts in making or defending a claim regarding waste or missing funds.

26. Equitable Divisions of Community Property / Reimbursement Claims / Offsets

As discussed previously, the Court has a certain amount of discretion in making adjustments regarding the division of property and debts between the parties where it is equitable to do so. These may be through an unequal division of community property or debts, reimbursement orders, and/or offsetting certain claims against one another.

     A. Offsetting Benefits Against Community Liens

Previously we discussed community liens where the community has made mortgage payments on separate property real estate or benefitted a separate property business. Although the community may be entitled to a community lien, there may be offsetting principles that can be argued. If the community received other benefits, such may in certain circumstances be offset against the community lien. For example, if the community received the rent payments on a separate rental property, such benefits may be offset by the Court against the community lien. In at least two prior published case opinions, the Court held that the non-owner spouse being able to live in the separate property residence rent free was a benefit to the community and was used to offset the community claim associated with the community’s mortgage payments.

A good attorney will be able to identify these offsetting principles and make valid arguments to the Court on your behalf.

     B. Unequal Divisions of Community Property – Where Equity Supports an Unequal Division

We previously discussed that Arizona law presumes that community property is to be divided equally. However, the Courts have recognized that some circumstances support an unequal division of community property where proof has been submitted to the Court that “equitable considerations” support such unequal division.

An obvious example of this is where one of the parties engaged in “waste” or diverted assets as described in the preceding section. Thus, if a party wasted or diverted community assets, the court may award the other party an additional amount of community property to make up for such waste.

There are other examples of unequal divisions of community property in published case decisions. For example, in one case one of the spouses during marriage transferred his property interests to the community, while the other spouse kept her interests as separate property. The evidence showed that the spouse that kept her interests as separate property appeared to intentionally manipulate the other spouse into making such transfers.

That being said, Courts have also held that one party merely gifting separate property to the community (for example by deeding separate real property in both parties’ names) by itself is not sufficient to support an unequal division after the fact. Rather, there must be additional extenuating circumstances that support such unequal division.

     C. Reimbursement claims – Paying community expenses post-service.  

One of the main areas we see reimbursement claims regards a spouse’s payment of community debts after service of the petition for divorce or legal separation. The reason for such claims is that after service of process the community is terminated, however, somebody still needs to pay the joint debts such as mortgage payments on the marital home (principal, interest, taxes and insurance), HOA fees, community credit card debts, etc.  It of course would be unfair for one spouse to pay the community liabilities with his/her post-service separate property income without contribution from the other spouse. Thus, during the divorce proceedings, if one of the spouses pays more of these expenses than the other, they have a reimbursement claim for the other spouse’s one-half share of such community bills. These claims are often referred to as “Bobrow reimbursement claims” after the published case law that specifically addressed such post-service reimbursement claim in the context of mortgage payments made during the divorce proceedings. Recent cases have made it clear that both parties have an equal obligation to make the mortgage payments on a community owned home unless one of the parties is forced out of the home (i.e., what the Court calls “ouster”). However, if one of the parties is excluded from the home as a result of an order of protection stemming from that spouse’s domestic violence, they will likely still have to pay their share of the mortgage payment even though they have no access to the property during the proceedings.

Under these principles, a spouse that makes post-service health insurance payments for the other spouse arguably has a 100% reimbursement claim since this is not a community debt post-service, and wholly benefits the other spouse.  Thus, although the spouse that carries health insurance is required to continue to do so pursuant to the Preliminary Injunction automatically issued in divorce cases, this does not mean that he/she cannot obtain reimbursement from the other spouse for such spouse’s portion of the insurance premiums paid.

There are certain community liabilities that may be paid post-service which are associated with a community asset such as automobile payments, but where such asset can only be realistically used by one of the parties. In such event, it is logical that the spouse using the asset should make the ongoing payments. However, there is no Arizona case law on-point that addresses  such circumstance. One can argue that under the Bobrow principles, both spouses have an equal obligation to make such payments post-service regardless of who primarily uses the automobile (unless an ouster applies). If both parties have an automobile to use, it is more logical that the payments for both be averaged and split between them until the case is finished.

Regarding post-service payment of community credit card debts, these too will likely be equalized so that the paying party is reimbursed one-half. This gets somewhat convoluted if one of both of the parties continue to use the credit cards after service of process as the post-service charges are sole and separate obligations. Thus, we generally advise our clients to obtain new credit cards in just their name so that detailed accounting is not required.

In most  cases, we are able to work out the offsetting post-service reimbursement claims between the spouses by agreement. This avoids substantial time and costs associated with submitting evidence at trial, which would generally involve copies of checks, credit card statements, and/or other documentary proof to the court of one’s expenditures during the proceedings.

There are many circumstances that may convolute reimbursement claims. In some cases, a spouse who makes all or most of the income may pay all or most of the community expenses during the proceedings instead of temporary spousal maintenance. In such event, a separate analysis of the spousal maintenance obligation should be made in order to properly offset such against the specific amount of the party’s share of the community expenses. A good attorney will make sure that these are properly identified and adjusted in an objective and quantified manner as opposed to making a generic argument that they should just be an equal “wash”.

The reimbursement claims described in this section are not automatic and may be subject to offsets or other “equitable” considerations.

Mr. Bishop drafted a very detailed article regarding these issues for presentations that he made to other attorneys during continuing legal education programs. Such article gets into these issues and nuances in far more detail. You can review Mr. Bishop’s article by clicking here.

     D. Reimbursement Claims that Arise During the Marriage.

There is the possibility a spouse may have reimbursement claims on behalf of the community against the other spouse that arose during the marriage itself. Some of these situations have been addressed in prior sections such as waste claims. We also discussed the situation where community funds have been spent on separate property real estate, or where community efforts and/or funds have led in part to an increase in value of a separate property business. In these cases the community may have a lien against the equity in the separate property real estate or business as discussed previously.

There are other examples that a spouse may have a reimbursement claim on behalf of the community. This may apply in other situations where community funds are used to benefit separate property or are used to make payments toward a sole and separate debt.

A distinction needs to be made between a situation where the community pays sole and separate obligations versus the other way around. Where sole and separate funds are used to pay community liabilities during the marriage, Arizona case law holds that such is presumed to constitute a gift to the community (certain exceptions may apply). However, where community funds are used to pay a sole and separate obligation, Arizona case law holds that the community is generally entitled to reimbursement. There may be exceptions to this rule as well, such as where the community received a reciprocal benefit. An example of this is where the community made payments on sole and separate student loans, but the community received increased income from the spouse resulting from his/her higher education.

One of the distinctions made in Arizona cases is whether the other spouse knew that community funds were being used to pay such separate obligations. If the spouse knew about such payments and agreed to such, the Court may reject an after-the-fact reimbursement claim made during divorce proceedings. This is common where a spouse makes his/her spousal maintenance payments or child support payments to a former spouse or partner.

One may think that reimbursement claims made years after the fact during divorce proceedings should be barred by the statute of limitations. However, Courts have held that the statute of limitations is “tolled” (extended) during marriage in order to avoid spouses having to sue each other while they are married.

In many cases, there are a number of reimbursement claims being made, which may be offset against each other to a certain extent if they are valid. Again, the Court has broad discretion in these types of reimbursement cases, and may make orders that it finds “equitable” under the circumstances.

Again, you may view Mr. Bishop’s continuing legal education article which gets into much more detail such reimbursement claims, including the many nuances and ambiguities in case decision by clicking here.

     E. Conclusion Regarding Equitable Remedies.

One can see that these “equitable” remedy arguments made during divorce proceedings can be very complex, and that the Court has a great deal of discretion in awarding reimbursement or offsetting such claims. Thus, it is important to have an expert divorce and family law firm your side.

Call our office today to schedule a consultation with one of our divorce and family law specialists. We will be happy to discuss your circumstances and your chances of success with regard to your own situation.