In every Arizona divorce, all marital property must be divided between the spouses. Whatever the property and wherever located, the family law judge determines who should get what and enters final orders. This is an essential step in dissolution proceedings because community property cannot exist outside a valid marriage.
Community property includes both assets and debts. No matter the size of the marital estate – grand or modest – divorce and legal separation require distributing furniture, bank accounts, and real estate right along with home mortgages, car loans, and medical bills.
With marital property interests held 50/50, the community estate is divided equitably and then distributed. Each former spouse begins life after divorce with all his or her separate property and half what they once owned together.
Community property division must be equitable, but seldom will shares be absolutely equal. In part, this is because the family law judge has considerable discretion over property awards. To achieve equity, the court has authority to divide assets and debts “in kind” where practicable, yet is not required to do so. Judicial discretion is the court’s flexibility in determining a reasonably fair division of the marital estate having considered the evidence and parties’ legal positions on disputed issues. What is deemed an equitable division depends upon the type, kind, and nature of the property placed under the judicial microscope. Is it an IRA? A service member’s military retired pay? The marital residence? A professional practice? Business goodwill?
Equal division need not be to the penny, and in-kind allocations should be reasonable. Is it reasonable to break-up the dining room set so each spouse gets an equal number of chairs? Still, many things can be divided with precision, such as equity in real estate, bank accounts, and retirement accounts. Start preparing for property division by grouping assets and debts into “community” and “separate” categories.
But for a few statutory exceptions, all property acquired during the marriage is community property. ARS § 25-211. For many couples, the marital residence is their most valuable community asset and the home mortgage their greatest marital debt. Less obvious as marital property are pensions, IRAs, 401(k)s, deferred compensation, stock options, commissions, salaries earned during the marriage and the things those wages purchased.
The community estate could include commercial property and time shares, automobiles and RVs, copyrights and patents, cryptocurrency and virtual assets, business ventures and professional practices, livestock and pets, appreciation on investments, rents and profits, antiques and art collections, and so much more.
Separate property belongs to only one spouse and is not divided in divorce. Unless spouses agree, the court cannot order one spouse’s separate debt be paid with the other’s separate funds or community share of the marital estate. ARS § 25-215.
Separate property is all real and personal property owned by the spouse before marrying or that he or she acquired during the marriage by gift, devise (with a will), or descent. Also included are any increases, rents, issues and profits on those separate things. ARS § 25-213. Items acquired after service of the divorce petition are also separate property, but only if a decree of divorce, legal separation, or annulment is entered. If spouses reconcile after marriage counseling, for instance, then divorce proceedings are dismissed without decree.
Must separate property acquired before the marriage stay separate no matter what? No, but it cannot transform without something more. How a separate asset is treated in the marriage may transmute or change its character into community property. A portion of an asset’s value may remain separate, while the balance is transformed into marital property. How was it used by both spouses? What were the circumstances? What did the owning spouse do with it during the marriage? Every case is unique and every asset requires careful consideration. Next is the four-step process used to characterize property for equitable division in divorce.
Sifting through the couple’s accumulated property, the judge makes findings by applying this four-step analysis:
All property interests must be disclosed during discovery, allowing the court to properly allocate them between the parties. If spouses have a prenuptial agreement, then that instrument with schedules and addendums is also submitted.
The property division process begins with identification. Identifying assets and debts starts with taking inventory. List everything from bank accounts and vehicles, to mountain bikes and patio furniture. Include everything each spouse owns or has a legal or equitable interest in. (Download our FREE e-book, Getting Started with 7 Must-Do Items for Divorce Planning.)
Property falls into two categories: Things tangible and things intangible.
Everything identified must be classified as either separate or community property. Consider an example in which the spouses own two vehicles. The husband bought his now-classic Mercedes-Benz for cash before they married in 2016. They financed a new Lexus in 2018 as wife’s primary mode of transportation. On those facts, the husband is awarded the Mercedes-Benz as his sole and separate property. The Lexus, acquired by the community during the marriage, is included in the marital estate for division.
An asset typically gets characterized as separate or community property at time of acquisition. Classification is not always obvious, though. The parties’ testimony and other admissible evidence help with the court’s analysis. Importantly, separate designation is not altered as a result of a subsequent marriage. When acquisition is followed by a wedding, the asset most likely remains separate property.
Does one spouse’s name on the title prove it is a separate asset? What about a separate debt? The community estate includes all property accumulated during the marriage, regardless of whether the title has one signature or both. Just imagine how impracticable daily life would be if both spouses had to sign every credit card transaction!
Things change when a spouse’s separate property is commingled, or mixed-in, with community property. Separate property is also transformed into community property by transmutation. Most couples will have some commingled and transmuted property to consider in their divorce. If the court determines a valuable asset was transmuted, then the impact on the marital estate could be substantial.
To transmute is to convert something into another form, like turning lead into gold. In Arizona property division law, transmutation turns something separately-owned into something community-owned. This happens routinely in most marriages, both intentionally and unintentionally.
There are limited ways in which transmutation during the marriage can occur:
Proving transmutation of separate property can be very technical, depending upon the type of asset.
In divorce proceedings, we presume the spouse made a gift to the community whenever he or she conveyed separate property to both spouses as co-owners. This is a legal presumption, rebuttable by a show of clear and convincing evidence that no such gift was intended. Difficult, but not impossible.
Consider an example of transmuted real property. The wife owned her home before getting married. A month after the wedding, she conveyed her house to “husband and wife as joint tenants.” In doing so, she gifted the home’s value to the community. Two years later, the husband petitioned for divorce. As a rule, when a party owned property prior to the marriage and subsequently conveys title in joint tenancy to both spouses, the value of the home is gifted to the marriage.
Another way transmutation can occur is by refinancing the loan on separate property during the marriage. Unless their separation agreement provides otherwise, re-financed real estate is divided as community property.
Property acquisitions made during the marriage are presumed to be owned by the community, but there are important exceptions. Was separate property acquired while married? For a party to overcome the marital presumption, ARS § 25-211(A) requires sufficient evidence to show:
Discuss strategy with an attorney. What evidence is needed to meet the “clear and convincing” burden of proof? To what extent did transmuting, commingling, or gifting property to the community take place?
The next big challenge is establishing reasonable value.
What is fair market value? Reality check. Unless they’re celebrities, the spouses’ most cherished items are probably of nominal value. Family photographs, birthday party videos, and refrigerator art are precious, but lacking monetary value. How can market value be placed on a pet cat or adopted dog? When both spouses desire items of purely sentimental value, the best way to divide those things is by settlement agreement – agree to a value and agree who gets it. (A pet custody plan could provide for quality time with animal friends, too.)
Valuation of community property is established using several methods:
The judge has discretion to set valuation dates and may attach different valuation dates to different assets. With assets that rapidly fluctuate in value, such as equities (or stock), valuation dates could be contested.
Some marital estates present greater challenges than others when it comes to setting values on assets. Traditional pensions and retirement plans cannot be divided immediately. Executive compensation packages are not clear-cut matters of salary, they may include deferred compensation, stock options, and other contingent benefits.
Valuation of a small business can be quite complex. Forensic valuation of a professional practice or closely held company may be needed, and will almost certainly be recommended by counsel, with several recognized valuation methods to consider.
Knowing all property must be identified and brought before the court for equitable division, a party may attempt to hide assets from the other spouse. Experience teaches attorneys how to spot red flags indicating concealed property, hidden debts, unlawful transfers, and undervalued assets.
Always communicate to your lawyer any concerns regarding depleted accounts, unexplained expenditures, and changed spending habits. In these situations, it is helpful to obtain an accurate summation of financial accounts, bank accounts, retirement benefits, real estate holdings, personal property, stocks and bonds, overseas assets, business revenues, and credit reports.
The purpose of these court proceedings is to arrive at the substantially equal, equitable distribution required by law. When identifying, classifying, and valuing property, details and discovery matter!
In marriages of long duration, the spouses had years to acquire assets which, in divorce, must be divided equitably between them. High asset divorces involving professional practices, complex investments, and the need to trace separate property interests over years of marriage can complicate the valuation process.
Where spouses have acquired substantial property, expert valuations help form a reasonable basis for their settlement negotiations. Divorce litigation to determine value is likely. Stewart Law Group works with reputable private investigators, forensic accountants, and skilled appraisers who provide expert witness testimony for clients throughout the Valley.
At trial, qualified experts assist the court by setting values in complex property division cases. Experts apply recognized analytical methods which vary depending upon the type of property being examined. Both parties may introduce expert opinions from forensic accountants, business valuators, appraisers, real estate brokers, and others. The judge makes findings by examining relevant evidence and extrapolating a range of reasonable value. In a battle of the experts, the court may determine which expert witness is more credible when methods and conclusions differ. Expert witness credentials matter.
In addition to testifying and preparing data for litigation, the forensic accountant conducts research to trace funds and identify assets, analyzes financial data, and prepares reports on findings. Accepted methods are used to value pensions and retirement plans, conduct a lifestyle audit, analyze whether an asset is separate or community property, determine marital waste, and discover fraudulently concealed assets. If an Arizona CPA, then the forensic accountant is licensed by the Arizona State Board of Accountancy.
When a business or professional practice needs valuation, forensic accountants with specialized training assist with that as well. Business valuation credentials include Accredited in Business Valuation (ABV), Certified Valuation Analyst (CVA), and Member of Appraisal Institute (MAI), among others.
Professional services – providers who are doctors, lawyers, accountants, engineers, architects, brokers – require valuation by a forensic accountant with credentials to testify as an expert witness in court. Business valuations are necessary, yet expensive and time-intensive, ordinarily taking several months to complete. In appraising the company, the expert begins by examining business records and conducting interviews of key individuals (including spouses and employees). Complexity of the valuation process and the methods utilized depend upon the type and nature of the business examined.
The services of various appraisers are useful when placing values on unique property items, such as collectibles, artwork, antiques, jewelry, guns, classic automobiles, musical instruments, books, coins, stamps, and the like. Services of more than one appraiser may be needed.
When spouses are not in agreement on real property values, a licensed real estate appraiser can provide a written appraisal report. Real estate appraisers locate comparable properties in the area, note sale prices of comparables, and estimate value for the subject property using standard methods.
For an informal valuation of residential property, consider a real estate agent. Local brokers and their agents know the markets where they work. What are residential properties selling for in Chandler? How long are Glendale single-family homes taking on average to sell? What is a reasonable listing price for the spouses’ marital home?
The process of dividing assets and debts is two-fold. First, the court awards each spouse his or her separate property. Second, because each spouse is entitled to one-half of the community estate, the court divides community property equitably. An equitable division should be substantially equal given the many factors the court must consider. Fairness is required, but without regard to a spouse’s fault or marital misconduct. ARS § 25-318(A).
A few examples of marital misconduct are abandonment, adultery, domestic violence, and substance abuse or drug addiction – none of which are relevant to the property division analysis in Arizona divorce. However, waste of community assets (for example, gambling losses or money spent on extramarital affairs) may be a factor the judge will consider. The party who committed waste by dissipating marital assets may be ordered to make an equalization payment to the innocent spouse, one sufficient to make up for a financial loss to the community. Given its discretion, the court may distribute some assets in kind, awarding Asset-A to one spouse and Asset-B to the other spouse. And make up for marital waste in the process.
Alternatively, the family law judge could order the property sold with the proceeds divided equally. This is often the best solution for the marital home, allowing any equity to be distributed in cash. The parties’ residence is sold, the mortgage satisfied, and the proceeds split equally.
Applying principles of equity, the court may grant reimbursement to a spouse in the property award. Did community funds pay for improvements to separate property? Were marital funds used to pay down the mortgage on a separate asset? The non-owning spouse may seek reimbursement to recover half the community money spent to maintain, improve, or pay-off the debt on the other’s separate asset. When one spouse used his or her separate funds to pay for improvements to their jointly held property, an equitable right to reimbursement may arise given the enhanced value of the property.
One can safely assume the judge will begin from the position community assets should be divided equally, unless there is reason to deviate. In divorce, the court cannot order a substantially unequal division of property held in joint tenancy for the purpose of reimbursing the spouse who used separate funds to acquire it. A substantially unequal division of real estate owned by spouses as joint tenants is possible, but only by agreement. The same rule applies to community property.
The judge will not order a substantially unequal division of community property for the purpose of reimbursing the spouse who used separate funds to acquire the asset. There is no reimbursement for subsequent expenditures on community property in a divorce either. Agreement between the parties could change that outcome. This is one of many issues to consider when negotiating a property settlement and separation agreement. ARS § 25-317.
An equalization payment is another way to achieve equitable distribution of community property. The court may order an equalization payment on its own authority, but the spouses could also agree to such a provision in their proposed property settlement. An equalization payment balances the ledger, dollar for dollar, so each spouse receives an equal award. Payment is typically made in installments or as a cash lump sum, although transfer of assets is another option if the parties so agree.
What do you know about divorce and taxes? Property transfers incidental to divorce, including equalization payments, are non-taxable events. In federal tax law, an equalization payment is made with after-tax dollars. Meaning the transfer is neither taxable to the recipient as income nor deductible from the payor’s income. Importantly, court-ordered alimony and spousal maintenance payments are treated differently under the Tax Cuts and Jobs Act (TCJA), effective January 1, 2018. See IRS Publication 504 for the tax consequences of divorce and separation. Consult a tax attorney, independent tax advisor, or Certified Public Accountant (CPA) about your specific circumstances.
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Before settlement negotiations begin, request the Arizona Divorce Handbook by attorney Scott David Stewart. You need to make informed decisions about your property. At Stewart Law Group, we help clients identify key negotiating points while protecting their rights and interests at trial and on appeal. Trust that the attorney who handles your divorce will implement a legal strategy consistent with your objectives.