If you are researching divorce or legal separation in Arizona, you probably already know that it is a community property state. While this is true, many people incorrectly assume that it means all property must be neatly defined as either community property or separate property. But Arizona law recognizes that the marital community may be entitled to an equitable interest in certain separate property—this is called a community lien.
Understanding how community liens work can be critical to protecting your financial interests during a divorce or legal separation. This article explains what community liens are and how they are calculated in Arizona family court proceedings.
Overview of property division
As mentioned above, Arizona is a community property state. What this actually means is that all property acquired by either spouse during the marriage is presumed to belong to the marital community, i.e. both spouses, regardless of how the property is titled.
This does not mean that individuals cannot acquire separate property during the marriage. It just means that the party who claims property is separate property must prove separate ownership by clear and convincing evidence. They can do this if they can prove that the property was acquired by inheritance, gift, or purchased with separate property. But perhaps the most frequent way the presumption of community property is rebutted occurs when one spouse signs a disclaimer deed.
Disclaimer deeds and community property
A disclaimer deed is a legal document that relinquishes or gives up one spouse’s ownership interest in real estate acquired during the marriage. Put another way, it is a document that enables a married individual to acquire real property during the marriage as separate property instead of community property.
Lenders often require disclaimer deeds when only one spouse qualifies for financing. Critically, a disclaimer deed executed for this purpose does not change its effect—the property will be viewed as one spouse’s separate property even when it is paid for with shared or community funds.
This is a really common misunderstanding. We frequently hear from people that they thought the disclaimer deed was just a formality necessary for the lender and that they believed the property would still be community property.
But whenever a disclaimer deed is signed, the property is acquired as one spouse’s sole and separate property.
This does not necessarily mean the spouse who signs the disclaimer deed has absolutely no interest in the value of the property. If the property is paid for with community funds, including income from either spouse’s employment during the marriage, the disclaiming spouse may be entitled to a community lien.
So what exactly is a community lien?
The term community lien refers to a marital community’s right to be reimbursed when community funds or labor are used to pay for or enhance the value of one spouse’s separate property during the marriage.
The basic idea is that the benefit (usually equity) gained through community efforts should be enjoyed by the marital community and not only the spouse who legally owns the property. This theory of reimbursement can apply to any type of property, but is most commonly used when a spouse uses community funds to pay for or improve real property.
This concept of the community lien can be based on community funds being used to (1) purchase the property or pay the mortgage principal; or (2) renovate or otherwise improve the value of the property. For improvements, the spouse asserting the community lien must prove the enhanced value, not just that renovations occurred. This is a common mistake we see from self-represented litigants and even inexperienced divorce lawyers. Bringing receipts from Home Depot will not be enough to establish a community lien. You have to prove that the specific renovations increased the value of the property.
Equally as important, not all payments toward separate property create a right to reimbursement. Payments toward mortgage interest, property taxes, property insurance, or routine maintenance are not grounds for reimbursement.
How are community liens calculated?
Arizona family courts have a lot of discretion when it comes to valuing community property, including community liens. There are two mathematical equations that family courts use 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.
These equations 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.
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 better financing terms.
The purchase price, $500,000.00, will be used for the “B” input. Next, let’s assume the parties paid $100,000.00 toward the principal of the loan between their down payment and mortgage payments made during the marriage. 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 ].
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. This would be the total community lien, not just the disclaiming spouse’s portion. This amount would be added with the other community property to be equitably divided in the divorce or legal separation. This means that absent extraordinary circumstances that justify an unequal division of community property, the wife who signed the disclaimer deed would be entitled to $55,000.
The math can be confusing, even to family lawyers, particularly those with little experience in property division. So we have built this calculator that you can use to calculate a community lien.
Essentially, the community is entitled to the principal of its investment in the property plus the proportionate share of any appreciation.
It also should be reiterated 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.
Additionally, this formula is only the starting point for family courts. A recent Arizona Supreme Court opinion made clear that family courts are not required to strictly follow its calculation in circumstances where it would be unfair to one spouse.
Common misconceptions about community liens
- Community liens are always calculated pursuant to the Drahos formula. The formula is just the starting point for Arizona family courts. Specific facts unique to a particular case may convince the judge to increase or reduce the community lien.
- Disclaimer deeds signed to obtain financing do not change the character of community property. As we mentioned before, a disclaimer deed can be enforced to make property acquired during a marriage one spouse's separate property even if it was signed only for the purpose of improving financing or loan approval. This scenario was specifically addressed in the Bell-Kilbourn case.
- Paying the mortgage with community funds makes a house community property. Unfortunately this is not the case. The character of property as separate property or community property is determined at the time it is acquired. Using community funds to pay for separate property can create the right to the community lien reimbursement though.
- Community liens only apply to real estate. This theory of reimbursement can apply to any separate property paid for or improved with community funds. We have established community liens for our clients related to automobile collections, coin and antique collections, retirement accounts, and numerous other types of property.
- Community liens are automatically calculated during divorce or legal separation. This probably should be ranked higher because this is really important—it is the burden of the spouse asserting a community lien to prove that community funds were used and to prove the enhanced value of separate property.
Why you should consider hiring a divorce lawyer
Calculating community liens can be complicated—this is actually one of the most frequently appealed issues in family law. Inexperienced family lawyers regularly make mistakes that can cost their clients tens of thousands (or more). Judges, even the Arizona Court of Appeals, cannot always agree on how community liens should be calculated.
Our experienced divorce lawyers can help you:
- determine whether a community lien exists
- calculate the value of the community lien
- trace separate and community funds
- protect your financial interests
- evaluate creative options to avoid litigation
We offer free initial consultations. Even if you intend to represent yourself, talking to a family lawyer early in the process can help you understand your rights in a way that may expedite quicker resolution of your divorce or help you avoid costly mistakes that may be irreversible later.
Conclusion
Understanding how community liens are calculated under Arizona law can make an enormous difference in the outcome of your divorce or legal separation. Because these issues can be legally and mathematically complex, legal advice can be invaluable.
If you have questions about community liens or property division in Arizona, contact us to schedule a free initial consultation with one of our knowledgeable family law attorneys.
