Married couples often strive to build financial security during marriage. They spend years, even decades, amassing a healthy marital estate without a thought of how to unwind it if the marriage ends. That’s why when divorce is imminent, the thought of dividing that security can be overwhelming and even terrifying. But it doesn’t need to be.
Separate vs. Community: Inception of Title Rule
A good starting point is to think of most marital property as fitting into one of four categories: community property asset, separate property asset, community property liability, and separate property liability. Categories help identify what needs to be divided, and there are basic guidelines for determining categories as well as anticipating potential problem areas. A court can divide all things that belong to “the community,” but cannot divide all things confirmed as “separate.”
Before placing property into a category, it must first be identified as an asset or liability. Next, it must be characterized as either community or separate. Here, the “inception of title” rule applies. If property was acquired before marriage or by gift or inheritance during the marriage, then it is determined to be separate. If it was acquired during the marriage and not by gift or inheritance, then it is community property.
Common Complex Property Issues
Unfortunately, not all marital property fits neatly into one of the aforementioned categories. Often, property is acquired in a more complex way. When that occurs, a multi-step legal analysis is needed and sometimes, a forensic CPA is engaged to trace or value more complex property issues. Such common complex issues include:
Reimbursement claims occur when one category of property is used to acquire, improve, or enhance another category of property. For example, let’s say a married couple purchases a home together but the funds used for the down payment are from the sale proceeds of the husband’s home owned prior to marriage. Is the home, an obvious asset, community or separate property? The inception of title rule tells us the house is community property because it was purchased after marriage, but the funds used to purchase the house are separate property because they were acquired prior to marriage. Here, the value of the house is divisible, but the husband has a reimbursement claim for the value of his separate property funds used to acquire the house. Meaning: husband is entitled to receive his funds back first before the value of the house is divided.
Comingled property occurs when separate and community property are merged together. This is often seen with financial accounts. For example: a wife has a brokerage account prior to marriage and once married, she continues to contribute funds to it. The inception of title rule dictates that the brokerage account itself is separate but not all funds in it are the same. Assuming the funds contributed during marriage are from the parties’ combined income, then some of the funds in the separate property account are community property. To determine how much of the funds are community, at minimum requires review of a) the brokerage account statement immediately prior to marriage and b) the most recent statement. Depending on the productiveness of the brokerage account, it may be beneficial to use a forensic CPA for tracing purposes. In this example — if you are the husband, the community value of the funds is critical but if you are the wife, the separate value of the funds is critical.
A business entity itself is not divisible, but the value of the interest in the asset as owned by one or both of the spouses is divisible. The inception of title rule still applies but the question centers around acquisition of the ownership interest. Corporate formation documents are critical here. It is imperative to have formal documentation identifying (a) who acquired the interest, (b) how much was acquired, (c) when it was acquired, and (d) what was offered in exchange for the interest. These facts contribute to whether the ownership interest is separate or community property.
Assuming the ownership interest is determined as community, it must be valued. Access to financial statements including profit and loss statements and balance sheets is imperative in determining that value. Other helpful documents include copies of share transfers, bank statements, and loan documents. Often, depending on the complexity of the entity, a forensic CPA is used to value the business and provide a formal report as to that value.
Dividing a healthy marital estate can be complex but it does not need to be overwhelming. Through a knowledgeable approach based on proper, thorough documentation, and with financial professionals and legal counsel who are well-versed in such complex matters, a person facing divorce can confidently navigate the division of their marital estate toward a greater sense of peace.