Chapter 8 Community & Separate Property

Chapter 8 Community & Separate Property2016-03-27T14:51:57+00:00

This chapter only applies to a married person who is a resident of a community property state who acquires or is contemplating acquiring a membership interest in an Arizona LLC.  The issues discussed in this chapter are base on Arizona law.  If you live in a community property state other than Arizona the community property law of your state applies to you and it may be different than Arizona’s community property.

Section 8.1 Why You Must Understand Community & Separate Property Law & the Consequences of Not Understanding

Because Arizona is a community property state, members and managers of the company should understand some important and fundamental concepts about Arizona community property and separate property law. Even if your Arizona limited liability company is owned solely by an entity, a trust or a single person now and the issues are not relevant today, it is possible that circumstances may change in the future and one or more married people might acquire membership interests in the company. Whenever there is at least one married person who owns a membership interest in the company, community and separate property issues will arise.

The following is a list of important concepts you should know about Arizona community property and separate property:

a. Only married people can own separate and community property.

b. The characterization of community property or separate property affects ownership of the property at issue. Ownership or lack of ownership has economic and other legal consequences.

c. If the property is community property, the spouses jointly own all of the property and each owns an undivided one half of the entire property. For example, if Arizona residents Jack and Jill are married and own a $200,000 debt-free home as community property, they jointly own the entire home and each owns an undivided one half interest in the home with a value of $100,000.

d. If one spouse owns property as separate property, then that spouse owns all of the property and the other spouse owns none of it. Using the same facts as in the preceding paragraph, if Jill owns the $200,000 home as separate property, she owns all of the home and Jack does not have any interest in it. Jill’s separate property interest in the home has a value of $200,000 and Jack has nothing.

e. Arizona has two types of community property:

(i) community property with right of survivorship (avoids probate), and

(ii) community property (probate required).

The difference between the two types of community property is that when spouses own property as community property with right of survivorship and one spouse dies, the other spouse automatically becomes the sole owner of the entire property without the need for an Arizona probate. If you want to avoid probate with respect to community property, make sure that the title to the “community property says community property with right of survivorship” and not merely “community property.”

f. When a spouse owns property as separate property and the spouse dies, the separate property may or may not be inherited by the surviving spouse. If the spouse who owns separate property has a Will, the separate property will pass to the heir(s) named in the Will. A surviving spouse does not automatically inherit separate property owned by a deceased spouse. If the owner spouse dies without a Will, the separate property will pass to the heir(s) of the deceased spouse according to the applicable laws of intestate succession and the surviving spouse may or may not inherit the separate property. Lesson: If a spouse owns separate property and wants to be sure that the proper heir(s) inherit the separate property after he or she dies, the owner spouse should have a Will that specifies the desired heir(s).

g. Arizona law has a presumption that all property acquired during marriage is community property unless the property came from a gift or from an inheritance. For example, if Jack is married to Jill and Jack’s parents give him $50,000, the gift is John’s separate property and Jill has no claim to or interest in the $50,000.

h. If a spouse who owns separate property is not careful, the owner spouse can transmute his or her separate property into community property owned jointly with the other spouse. For example, if John deposits his $50,000 gift from his parents into his joint checking account with Jill, John will convert his separate property gift to community property owned jointly by both spouses. Another way to convert separate property into community property is to take community property such as salary earned by either spouse and use some or all of the salary to pay the mortgage on or make repairs to a home that is owned as separate property by one of the spouses. Lesson: Never use community property to benefit separate property (unless you want to convert it to community property) because it will convert some or all of the separate property to community property.

Section 8.2 How to Determine if a Married Member Owns an Interest in the Company as Separate Property or Community Property

The legal significance of the presumption of Arizona law that all property acquired during marriage (other than from a gift or an inheritance) is community property is that the burden is on the spouse who claims the property is separate property to prove that the property is not community property. Translation: Property acquired by an Arizona resident during marriage will be deemed by an Arizona court to be community property unless the person who claims separate property has some real and substantial proof that that the property is not community property.

If a married man files Articles of Organization with the ACC that names only the man as a member of the company and there is no Operating Agreement or an Operating Agreement that does not name the wife as a member of the company, Arizona law provides that the woman owns a community property interest in the company with the man. The fact the woman is not named as a member in the Articles of Organization or the Operating Agreement does not mean that she does not have a community property interest in the company. She will own a community property interest unless the man can produce evidence to the contrary.

Section 8.3 Disclaimer Form to Be Signed by a Spouse Who Does Not Have an Interest in the Membership Interest of His or Her Spouse

The best way to prove that a membership interest of a married spouse is separate property is to have the nonmember spouse sign a document in which he or she disclaims and waives any interest in the membership interest of the member spouse. I call this type of document a “Disclaimer.”

If the LLC Formation Questionnaire you submitted to us indicated that any married member was to own his or her membership interest as separate property then we prepared a Disclaimer for the member’s spouse to sign.  This Disclaimer is found under the Operating Agreement tab of your LLC portfolio at the end of the Operating Agreement.

The text used in the Disclaimer is contained in Section 6.2 of the Operating Agreement.  If you need a Disclaimer, copy the text found in Section 6.2 of the Operating Agreement and edit it as necessary for the married couple who are the subject of the Disclaimer.

It is also prudent that the members of the company sign an Operating Agreement that states the interest of the member spouse is owned as separate property.  However, without a Disclaimer signed by the nonmember spouse, the Operating Agreement will not be determinative with respect to the issue of how a married member who is a resident of a community property state holds title to his or her membership interest.

Section 8.4 About the Disclaimer Found at the End of Your Operating Agreement

You should assume that any member who is a resident of Arizona and who is married when the member acquires a membership interest in the company will own his or her interest in the company as community property with the member’s spouse unless the nonmember spouse signs a disclaimer in which the nonmember spouse disclaims any interest in the membership interest of the member spouse. If the LLC Formation Questionnaire you submitted to us indicated that any married member was to own his or her membership interest as separate property then at the end of the Operating Agreement we prepared for the company you will find a Disclaimer for each non-member spouse.

A nonmember spouse who signs the disclaimer will acknowledge that the nonmember spouse does not have any interest in the membership interest of the owner spouse and that the member spouse owns his or her interest in the company as separate property, not community property.

WarningA married member who intends to own his or her interest as separate property must have the spouse sign the Disclaimer to obtain clear title to a separate property ownership interest in the company.

Section 8.5 Statement of Character of Membership in the Operating Agreement

This Section applies only if your company has any members that will own their interest jointly. It does not apply if the company does not have a person who is a member.

Section 3.2 of the Operating Agreement states how the married members who own their membership interest jointly will hold title to their membership interest – either as community property with right of survivorship or as joint tenants. Married members who own their interests as community property with right of survivorship each own an undivided one half interest in the membership interest, and on the death of the first spouse, the interest of the deceased spouse passes automatically to the surviving spouse without the need for a Will or a probate. Members who own their interests as joint tenants own undivided ownership interests that pass on death to the surviving joint tenant(s), but joint tenants may include people who are not married to each other.

Section 8.6 Affect of Arizona Community Property Law on Nonresidents of Arizona

Caveat: The discussion in this Chapter about community property and separate property is a general discussion of Arizona community and separate property law, which applies to members who are residents of Arizona. We cannot predict or comment on how a court in a state other than Arizona will treat membership interests in the company owned by married members who are not residents of Arizona. If we prepare the Operating Agreement to state that the membership interest of a married non-Arizona member is separate or community property and/or prepare a Disclaimer for the non-owner spouse to sign, it does not mean that a non-Arizona court will apply the law of its state in a way that is contrary to Arizona law. Non-Arizona residents who are married should consult an attorney in the state in which they reside to determine how their membership interest in the company will be treated in their states and take any action necessary to protect and/or substantiate their interests in the company.

Section 8.7 Disclaimer to Be Signed by Spouse of a Member Who Owns His or Her Interest as Separate Property

If the LLC Formation Questionnaire you submitted to us indicated that any married member was to own his or her membership interest as separate property then at the end of the Operating Agreement you will find a document entitled “Disclaimer of Membership Interest” for each member who is to own an interest in the company as separate property. This document should be signed by each spouse of a married member who is to own the member’s interest in the company as separate property.

If your company does not have any married members currently, the sample Disclaimer found in Section 6.2 of the Operating Agreement may be needed in the future if the company ever has a member that is married. If the married member wants to own his or her interest in the company as separate property, the married member must arrange for his or her spouse to sign the Disclaimer of Membership Interest and the married member and the company should keep the signed Disclaimer of Membership Interest in a safe place for future reference. Because Arizona law presumes that all property of Arizona residents acquired during marriage is community property unless it is acquired by gift or inheritance, the non-member spouse must sign the Disclaimer or he or she may claim a community property interest in the membership interest of the spouse who is supposed to own a separate property interest in the company.