Community Liens Separate Property

The Scottsdale attorneys at Hildebrand Law, PC want you to know more about community liens in sole and separate property in Arizona. The Arizona Court of Appeals in the case of Potthoff v. Potthoff had to address an Arizona divorce court’s ruling that land husband, Herbert Potthoff, owned prior to marriage was transmuted from separate property to community property and, thus, wife, Gertrude Potthoff, was entitled to an equitable share of that property.

The appellate court began its analysis by relying upon the seminal Arizona case of Cooper v. Cooper, which held that property acquired prior to marriage is the sole and separate property of the spouse who owned that property prior to marriage and that property acquired during marriage is presumed to be community property.

The appellate court added that property acquires its status as sole and separate property at the time it is acquired, citing the Arizona Supreme Court case of Lawson v. Ridgeway. Further, the date of acquisition is determined as of the date the contractual right to have title to the property occurs, not when title is actually subsequently transferred, citing a New Mexico Supreme Court case of Hollingsworth v. Hicks as authority.

The appellate court specifically found that the real estate at issue in this case are, in fact, Herbert’s sole and separate property. The court, therefore, analyzed the case to determine if the nature of that property changed to community property by agreement of the parties or other operation of law.

The appellate court found that the use of commingled or community funds to pay the obligations on the properties did not change the character of the property and, at most, the community may have a community lien against Herbert’s sole and separate properties, citing the Arizona cases of Lawson v. Ridgeway and Tester v. Tester as authority.


Community Liens Separate Property | Valuing the Community Lien in Separate Property

The appellate court went on to rule that use of community funds used by Herbert to build a shopping center on one of the properties during the marriage also did not change the character of the then vacant land into a community asset, citing the Arizona case of Lawson v. Lawson as authority. The court cited the Arizona Supreme Court case of Brown v. Brown that “improvements” to property acquire the characteristics of the property upon which those improvements are made, such that improvements to separate property made during the marriage remain the separate property of the spouse owning that property as his or her separate property.

The appellate court also rejected Gertrude’s argument, citing the case of Porter v. Porter, that her mere signing as a guarantor on the construction financing loan to build a shopping center on Herbert’s then sole and separate property transformed the property into a community asset.

The court also rejected Gertrude’s argument that Herbert’s expenditure of time and effort in overseeing the construction and subsequent operation of the shopping center transmuted that property to community property. The court held that, pursuant to the prior ruling in Cochrill v. Cochrill, there may be a community interest in the “profits” of a sole and separate business in the form of a community lien, such labors do not change the character of the property as Herbert’s sole and separate property.

Lastly, the appellate court rejected Gertrude’s reliance on th California Supreme Court of In re Nelson’s Estate for the proposition that Herbert transmuted the property from sole and separate to community property simply because the parties’ listed those properties on their income tax returns as community property. In certain circumstances that case may apply to support a claim property was transmuted, but it does not do so automatically as a matter of law.


Community Liens Separate Property | Devalued Property

Arizona uses the community property system to divide up property between spouses when they divorce. Under this system, everything earned by either spouse during the marriage belongs to the marital community and, in case of divorce, is divided equally between them. If a spouse owns property before marriage or receives as a gift during marriage, that is her separate property and need not be divided with the other spouse.

However, if one of the spouses owns a house as her separate property and she uses community property money to pay down its mortgage, the community gets a legal interest in that property called an equitable lien. That means that the community gets reimbursed when the couple divorces and can also share in any increase in the property value that occurred during the marriage. What happens, however, if property values go down during the marriage?

In the case of Valento v. Valento, 240 P. 3d 1239 (Ariz. 2010) the Arizona Court of Appeals discussed that issue: how to determine the value of an equitable lien when the market value of that property went down during the marriage.

Jill and Marvin Valento married in 1999 and filed for divorce in 2008. During their marriage, Jill and Marvin bought a house they lived in. Marvin signed a disclaimer deed during the marriage stating that this house was Jill’s separate property. The couple was also given an interest in a condominium in Minnesota by Marvin’s parents as joint tenants.

The main argument at trial concerned their marital residence. Jill claimed at trial that she bought it for $1.2 million with a $560,000 down payment and a mortgage of $650,000 but, during the marriage, she paid down the mortgage with $200,000 of community funds. The value of the house declined over the past few years of the marriage.

The superior court ruled that Marvin’s disclaimer was effective to make the house Jill’s separate property. But it also ruled that the community had an equitable lien on the house based on the reduction of the mortgage principal ($200,000) resulting from the contribution of community funds.


Valuing the Equitable Lien in Devalued Separate Property in Arizona

The Court of Appeals accepted the lower court’s determination that the marital home was Jill’s separate property. It noted that the trial court has the job of weighing conflicting testimony and evidence and that its decision would not be changed on appeal unless it was an abuse of discretion.

However, the appellate court reconsidered the issues about the equitable lien. Jill argued that there should be no equitable lien on the property because the house decreased in value during the marriage. The Court found that even if the value of the house declined, Jill still benefited when the community paid down the mortgage by $200,000. Therefore, the community was entitled to at least that much in an equitable lien if Jill still had positive equity in the property, e.g. if Jill could sell the property for more than she owed on it. If the value of the house has gone up during the marriage because of the real estate market, the community was also entitled to a proportionate amount of that increased equity.

Although Jill claimed that the property value had gone down significantly, the superior court had not determined the value of the property, nor whether Jill still had positive equity in the property. The Court of Appeals sent the matter back down to the superior court to make these determinations.

The Court noted that even if Jill’s equity in the house was negative, the equitable lien did not vanish. Instead, it would be reduced proportionately according to this formula: C-[C/B × D]; where D = depreciation in value of the property during the marriage, B = value on the date of marriage, and C = community contributions to principal or market value.

Marvin’s parents made a gift of the Minnesota property to Marvin and Jill as joint tenants, and reserved a life estate. Marvin testified at trial that his parents conveyed the property for estate planning purposes with the understanding that the property would go to his children when his parents died. The deed, however, does not mention Marvin’s children, but granted the property to Marvin and Jill as joint tenants.

Jill argued that because the language of the deed was clear, Marvin’s testimony could not be admitted. The Court of Appeals agreed. Arizona’s parole evidence rule allows in evidence about the intent of the makers of a contract if the terms of the contract are ambiguous. However, no testimony about intent is permitted to contradict the clear terms of a written contract.

Since the property was a gift, each spouse holds an equal share as separate property. The Court of Appeals ordered the superior court to divide the joint interest between them.