Asset and Property Division
Arizona is a Community Property state, which means that all property obtained by each spouse during the marriage is owned equally. This Community Property is divided during a Divorce equally or equitably if certain types of property are unable to be divided equally.
Community Property is generally described as all property acquired by either spouse during the marriage except such property that is specifically defined by Arizona law as Sole and Separate Property, such as property owned prior to marriage, inheritance or gifts from non-spouses. Therefore, it generally does not matter what spouse’s name assets are placed in if such asset was acquired during the marriage. For example, sometimes spouses keep separate accounts. Unless there is a premarital or post-marital agreement defining the parties’ rights differently, it does not matter if the parties kept separate accounts. Funds acquired from income earned during the marriage would still be Community Property. Another example would include automobiles. It does not matter whose name is on the title. Rather, if the automobile was purchased during the marriage from community funds, it would be Community Property.
Some people think my income is mine, and the other parties’ income is his/hers. That is simply not the case when you are married. If the funds were earned during the marriage by either party, such funds are considered Community Property.
Arizona case law provides that Community Property is divided equitably. Absent other considerations, this generally means that all Community Property is divided equally. Again, this is regardless of whose name the asset is in. Although this does not occur often, there are times that Community Property can be divided unequally by the Court.
Community Property laws are, can be confusing. Generally, there are two kinds of property. The first kind of property is called “Real Property,” meaning real estate (houses, land, etc.). The other general kind of property is “Personal Property,” meaning everything else (furniture, financial assets, and anything else of value). Arizona law sometimes has different laws apply to different types of assets, most notably between Real Property and Personal Property.
There are times that something that would otherwise be a community asset could be converted into a sole and separate asset. A common example of this is when a spouse signs a disclaimer deed and places Real Property (i.e. a home or land) into the other spouse’s name. Arizona cases have held that it may enforce such disclaimer deed, and thus recognize the property as Sole and Separate. However, there are contrary arguments that can be made, including fraud or mistake, or the fact that the community paid the mortgage and other expenses associated with the home. These can be very technical issues.
Some assets can be mixed (i.e. partially Community Property and partially Separate Property). For example, 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 account for the difference in values. With regard to Qualified Retirement Accounts, such as 401Ks, the parties will often need to hire an Expert who can draft a Qualified Domestic Relations Order (“QRDO”) or other type of order to provide for such equalization or division.
Arizona law defines Separate Property as property that is acquired prior to marriage, or received as a gift from a third party, or received by inheritance. This also includes gains on such property (such as rent, interest, etc.). If somebody transfers their Separate Property from one account to another, or if they purchase assets with such Separate Property, what they buy or invest in generally stays separate property so long as they can show (“trace”) where the funds came from.
However, there can be Separate Property issues that arise during an Arizona divorce. If there is an increase in value of the property as a result of the efforts of either spouse, the community may have a claim to some or all of the increase in value. A common example is a sole and separate business which increases in value during the marriage.
Additionally, if Separate Property is Co-Mingled with Community Property, then it can be consider all Community Property. This is generally done by mixing funds, otherwise known as “Co-Mingling”. This is often done when a spouse adds their income during marriage to an account that they had before marriage, and then makes various transfers and expenditures from such account. If there has not been very much Co-Mingling, you may be able to “trace” what portion of the account is a Community and what portion is Separate. However, if the Co-Mingling is too extensive, you may not be able to trace the separate portion to the extent required by the law. In that event, the separate portion of the funds are not “explicitly traceable,” and thus the entire pot becomes Community Property and subject to division. If the funds in the account are substantial, a forensic accountant is often retained to determine if the funds can be traced to the extent required by the law.
Generally, adding the name of the other spouse to a sole and separate account does not, by itself, convert the account to Community Property (assuming that the account is not Co-Mingled and untraceable). The Court will look to the intent of the party by adding his/her spouse’s name in making such determination.
Another example is when one of the parties owned real estate (home, land, building etc.) prior to marriage and then adds the other spouse to the deed as a Joint Tenant or as Community Property. In such event, Arizona law handles this differently, and the home or other real estates that would have otherwise been separate is presumed to be converted (or gifted) to the community and is thus subject to division.
If you own a home that was purchased during the marriage, it is likely Community Property to be divided as part of the divorce process. Your home may not be a community asset if a Disclaimer Deed was signed.
A Disclaimer Deed is a legal document that relinquishes or gives up one spouse’s interest in real estate acquired during the marriage. Lenders often require Disclaimer Deeds when only one spouse qualifies for financing. When a Disclaimer Deed is validly executed, the property is acquired as one spouse’s sole and separate property. But this does not necessarily mean the spouse who signs the Disclaimer Deed has absolutely no interest in the value of the property. Most real estate, particularly residential real estate, is acquired subject to a mortgage. If the mortgage is paid with community funds, including income from either spouse’s employment, the disclaiming spouse may be entitled to a portion of the equity gained.
If the marital home is considered Community Property, then it will be divided in one of three ways. One spouse will stay in the home, refinance the mortgage into their own name, and pay the other spouse their net equity share, or the reverse of this option. Or, the home will be listed for sale and the next equity proceeds divided equally.
A Community Lien is an equitable interest in an individual’s Sole and Separate Property created when community funds (or other efforts including labor) are used to pay for or improve the value of the property during a marriage.
When contributions of community funds or labor are used to benefit a spouse’s Sole and Separate Property the community is entitled to a Community Lien “reflecting its contribution to the increase in the property’s value.”
When community funds are used to make mortgage payments on separate property the Drahos/Barnett formula can be used to reimburse the community accordingly.
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.
Pensions, 401(k)s, IRAs, and Qualified Retirement Plans will be divided, as part of the divorce process, if community contributions were made into those accounts during the marriage. Spouses may each have their own retirement plans, or it may be that only one has a pension because the other spouse was not working during the marriage. What is important is what percentage of the retirement plan (if any) was funded during the marriage and, subsequently, what portion should be transferred to the non-participant spouse. After that is determined, the court will issue orders to carry out division of the retirement asset. This order is called a Qualified Domestic Relations Order (“QRDO”).
The QDRO provides two significant protections. First, it assures the required payment is made directly to the other spouse. This prevents the plan participant from disposing of his or her share of the pension in violation of the divorce decree. Second, the QDRO ensures that each party is responsible for a proportionate share of the tax liability. Basically, the community amount each spouse is entitled to is rolled into a separate retirement account for them, avoiding any early withdrawal or tax penalties.
The QDRO instructs the retirement plan administrator to distribute a specified percentage of the participant’s benefit to the other spouse. When both spouses have their own retirement plans, each plan may be divided in the divorce.
A Pension provides the recipient a series of monthly payments for either a fixed period of time or for the lifetime of the employee after that employee reaches retirement age. In dividing a Pension during a divorce, the spouse will receive either a lump sum value of their community portion of the spouse’s benefit, or a fixed number of the spouse’s Monthly Pension Benefit. This is different that dividing a traditional Retirement Account, like a 401k or IRA. A 401(k) or IRA are easier to divide because you will know the exact value of those Retirement Accounts and can calculate the Community Property portion of those accounts.
A Pension is considered a “Defined Benefit Plan”, which is a plan where you may or may not invest money into the plan and you will receive a monthly amount at a certain age, like a Pension. You may or may not be entitled to the value of the account in lieu of or in addition to monthly Pension payments; depending upon the plan.
A.R.S. § 25-318(B) allows a judge to consider the taxes that will become due upon the sale of an asset, such as capital gains taxes on a home. However, an Arizona judge may only consider those capital gains taxes if a sale of the home is imminent.
There are also income tax issues related to monies held in some Retirement Accounts. This means you should not treat $50,000.00 in a bank account the same as $50,000.00 in a Retirement Account because the money in the Retirement Account will be subject to being taxed while the money in your bank accounts is not taxed when withdrawn.
Spousal Maintenance was tax deductible to the person paying Spousal Maintenance and was taxable income to the person receiving spousal maintenance for orders entered before the end of 2018.
Changes in federal law removed the tax effect on spousal maintenance starting in 2019. Awards for spousal maintenance entered after January 1, 2019, are no longer subject to taxation or as an income tax deduction.
Child Support has never been taxable in Arizona. The current law applying to the tax effect of an alimony award, likewise, has no effect on the fact that Child Support is neither tax deductible by the person paying Child Support or taxable income to the parent receiving the Child Support.
The forgoing is not meant as tax advice, and we have no particular expertise in tax situations. You should seek advice from an independent tax professional. This material should not be relied upon since every situation is different and fact specific.