California is a community property state, and as a result, the basic principle that governs the division of assets upon divorce seems simple enough. Each spouse is entitled to one-half of the property that was acquired during the course of the marriage. As basic as this sounds, the financial reality of dividing assets can be complex. Remember, upon divorce you and your spouse are essentially selling everything you own to (a) each other, or (b) a third party.
Spouses who mediate their divorces enjoy the ability to divide their assets in the manner that best meets their respective needs. Allowing a judge to manage this task often leaves both parties deeply dissatisfied. Nevertheless, gaining a basic idea of how a judge might divide property if negotiations fall apart is a useful place to start.
Before property can be divided and distributed, it must be characterized as "separate property," "community property," or "quasi-community property."
Separate property : Any property acquired before marriage or after separation is considered the acquiring spouse's separate property. The time of acquisition is therefore important, and is typically set at the time when the original property right arose. For example, this would be the date a contract was signed to purchase an automobile, not the date the DMV confirmed title.
Property acquired by "gift, bequest, devise, or descent" is also characterized as separate property. For example, if your father leaves you $100,000 in his will, that money is your separate property. Likewise, if your spouse gives you a diamond necklace, the gift is your separate property.
In addition, any assets acquired after the date of separation (but before divorce) are considered the separate property of the acquiring spouse. For example, if your date of separation is June 15, and you buy a new automobile on September 15 using payments you received in the interim as temporary support, that automobile is your separate property.
Community property : All property acquired during marriage and before separation, other than by gift or inheritance, is presumptively community property. This includes all compensation, regardless of the form it takes, a concept that will become more importance when determining how much (if any) child support or spousal support is appropriate. The following are examples of compensation:
All earnings from a privately held business are considered community property to the extent they reflect either spouse's participation in the business. On the other hand, earnings that don't reflect the labor or skill of either spouse are considered a return on a capital investment. As a result, these earnings are instead characterized as separate or community property based on the date of the original investment. This may sound confusing at first blush, but the concept makes sense. Consider the following example:
Before marrying Sue, John Smith invested in a fast food franchise along with two of his close friends. The franchise did fairly well, but by the time John and Sue were married, he was a completely silent partner. He did nothing more than collect his share of the profits generated by the franchise. The income generated by the fast food franchise that is payable to John will be considered his separate property. He did no work to generate those profits during the course of his marriage to Sue. The "seed was sown" before they were married. Therefore the earnings from the franchise are not community property.
Contrast the previous example with the following: Before marrying Sue, John opened an accounting practice. Getting started took quite a bit of time, and the practice wasn't even profitable by the time he married Sue. In this case, valuing the business will be quite difficult. Some portion of goodwill is attributable to the work John did before marriage, but the income derived from the practice after marriage clearly reflects John's labor and skill, and is therefore community property. In a case like this, and outside expert may be required to properly value the business.
As a general rule, simply remember that any asset obtained or income earned during marriage is community property. This includes the right to receive income in the future - for instance, through a grant of stock options or some form of deferred compensation.
California Family Code Section 910 states that all debt s incurred during the marriage and prior to separation are community property. It doesn't matter whether the debt was incurred by one spouse for his or her own benefit or for the benefit of the family. It also doesn't matter whose name appears on a bill or a credit card statement. If it was incurred during the marriage and prior to separation, it's a community property debt and both spouses are equally liable for its repayment.
Quasi-Community Property : California Family Code Sections 125(a) and 125(b) define "Quasi-Community Property." In short, quasi-community property is real estate and personal property acquired by a spouse while living out of state that would have been community property if the spouse had been domiciled in California. The definition of quasi-community property also includes any property that is acquired in exchange for such property. Quasi-community property is a means for California courts to obtain the authority to dispose of non-California assets in a divorce.
Additional Important Concepts
Date of separation : In dividing earnings and income during the divorce mediation process,, the date of separation becomes a very important point of reference. California Family Code Section 771 indicates that "separation" requires more than a rift in the spouses' relationship. The "date of separation" occurs only when the parties have parted ways with no present intent to resume their marriage. The conduct of the spouses must demonstrate a complete and final break in the marital relationship.
Date of divorce : Unlike earnings and income, which lose their community property nature after the date of separation, community property assets are valued as near as possible to the trial date . According to California Family Code Section 2552, "the court shall value the assets and liabilities as near as practicable to the time of trial." In other words, if a community property asset appreciates significantly during the interval between separation and divorce, that appreciation is split evenly between the parties.
For example, Sue and John agree that their marriage is troubled. On August 1 st they decide to separate to "test the waters." John moves out of the house. They both agree that they want to preserve the possibility of getting back together. December 5 rolls around, and John sends Sue a letter stating that the marriage is over, he isn't coming home, and he wants a divorce. The date of separation is December 5, not August 1. The decision to separate on August 1 is too tentative to reflect the "date of separation" under California law. Any earnings or assets accumulated between August 1 and December 5 are community property.
Transmutation : As set forth in California Family Code Section 850(a)(b) and (c), spouses may agree to change the nature of any or all of their property. In other words, they can agree to change separate property into community property and vice versa. This may be accomplished by a marital property agreement. In addition, California courts will typically honor premarital agreements that are entered into freely and knowingly, and which alter each spouse's property rights as set forth by California law.
Assets v. income : This distinction may seem unimportant at first glance, but keep in mind that the two have very different consequences during divorce. Community property assets are divided equally, while income is used to determine how much alimony and child support is appropriate.
Asset Division, Practically Speaking
The intense stress of divorce often causes couples to ignore the many costs associated with dividing or selling assets. The consequences of doing so, however, can resonate for years to come. As with any other aspect of your divorce, you will benefit greatly if you and your spouse reach a fair settlement outside of court. Keep in mind that courts do not typically account for the various costs associated with maintaining and selling various assets, such as insurance, maintenance fees, commissions, and taxes. Nowhere is the disparity between the legal reality of divorce and the financial reality more glaring than when your assets are divided.
Consider the following simple scenario: John and Sue Smith are in the midst of a divorce. The Smiths have $100,000 in cash and shares of a mutual fund valued at $100,000. Despite the poor state of the economy, the mutual fund has done quite well, returning nearly 8% per year. Clearly the mutual fund has done much better than the tiny return earned by cash in a savings account. Therefore, it might seem that if the cash goes to John and the mutual fund to Sue, Sue is in a good position. After all, why not stick with a winning investment?
In reality, Sue is getting a raw deal. All of the accumulated capital gain will be taxed when the mutual fund is sold, and Sue will be wholly responsible for paying the taxes. If the Smiths held the shares for many years and the value of the shares rose significantly, the tax bill could be substantial - many thousands of dollars. The net effect is this: John is getting a better deal by walking away with cash.
If you have a financial advisor, consulting with him or her will be an important part of the divorce process. He or she may be able to assist you in determining how to appropriately value and divide certain assets. Determining the true value of various assets ranges in difficulty from incredibly simple to fairly complex. The following will get you started:
Cash and receivables : Simply perusing your bank account statements should give you an accurate picture of the amount of cash you hold. Don't forget to search your files for copies of any receivables (i.e., money due to you under a personal loan). Many families loan money to other relatives on an informal basis. While formalizing such loans is essential and avoids the inference that such a loan was actually a gift, you'll nonetheless want to get a handle on all loans (informal and formal) you or your spouse have made to other individuals.
Stocks and bonds : If you use a brokerage firm or an online service to purchase your stocks, you can either (i) call the firm's trading department and ask them to give you the current price of a stock or fund, (ii) simply check the business section of the paper, or (ii) locate the price on any one of the numerous financial websites that crowd the internet. Your brokerage firm should be able to help you with the value of your bonds.
Insurance : Assuming you are listed as the owner of the policy, the insurance company or broker who obtained the policy for you should be able to give you the policy's current value and surrender value. If you don't own the policy and you have a cooperative spouse, ask your spouse to provide you with the required information. If you are embroiled in litigation, this information may have to come out during the discovery process.
Collectibles and other personal property : A highly regarded estate planning attorney once remarked, "The second you walk out the shop door with a piece of jewelry or a collectible, you've taken a 50% loss." There is a great deal of truth to his off-the-cuff comment. Collectibles are rarely worth as much as their owners like to believe. The key here is to get an appraisal. When valuing an item, make sure you use its resale value, not its retail price. Unfortunately, you may hear a host of different values according to who is performing the appraisal. The trick is to find a valuation that both you and your spouse find acceptable.
The closely-held business : Because they aren't listed on the various exchanges and therefore can't be sold easily, sole proprietorships, partnership interests, stock in privately held corporations, and membership interests in limited liability companies can be quite difficult to value.
Appraising a private business is part art, part science. In a contested divorce, valuing a small business can turn into a battle of appraisers. Thankfully, though, valuing a company is less of a guessing game than it used to be, partially due to a constantly growing database of information on comparable sales, which can be accessed through entities such as BizComps and the Institute of Business Appraisers.
While a public company can fetch upward of thirty times its earnings on the market, a private company may be lucky to sell for five times its annual earnings. Buyers place a premium on one simple factor: predictable and growing cash flow. Of course, if your business happens to hold promising intellectual property, an appraisal based on cash flow isn't appropriate.
Certain intangibles also affect the value of a business. Location can be very important. A technology company in San Jose might garner a higher bid than a rival in Stockton simply because the quality of the workforce and its proximity to the industry's nexus. Likewise, a company that manufactures a car part with ten customers will fetch a lower price than a competitor of similar size that boasts fifty reliable customers because it doesn't enjoy a revenue source that is quite as a diversified.
A private company that is on the cusp of going public will undoubtedly fetch a much higher price than one that is less growth oriented, and a company that is likely to be sold to a "strategic buyer" - one that will use the company to expand its product line or territory - will garner a generous price.
Sound complicated? It certainly can be. If you own a "mom and pop" store that has maintained fairly consistent revenue over the course of two decades, valuation should be relatively simple. If you own a company that is growing like mad, or that has developed some particularly valuable intellectual property, you will need a great deal of help. This comes at quite a cost, but it is the only way to get a reasonable ballpark figure.
Selecting the right professional to appraise your business can be equally daunting. A CPA with no specialized training is business valuation is probably a poor choice, while one who is a certified valuation analyst is a better bet. A mergers and acquisitions specialist may also be able to provide you with a reasonable appraisal.
If you're serious about getting your business appraised, keep in mind that this can involve quite a bit of work on your part. Already emotionally exhausted from your divorce, the last thing you'll want to do is gear up for a true valuation. You can expect to produce several years' worth of financial statements and explain them in excruciating detail.
How much does a business appraisal cost? It varies according to the size of your company, but to give you a general sense of the fees involved: A business with less than $1 million in annual sales and good record keeping might incur a fee of $5,000. A company with $15 million in sales could pay many times that amount simply due to the complexity of its accounts.
Stock options : An increasingly important part of many employee's compensation packages, stock options require careful consideration during the divorce process. Stock options are deceivingly simple compensation contracts. When an option is exercised, its payoff rises by one dollar for each dollar the stock price is above the exercise price (also called the strike price). If the stock price is below the exercise price when the option matures, the option is not exercised and it has zero payoff. Despite the basic nature of this concept, few employees truly grasp all of the implications of option ownership. Indeed, survey after survey has shown that employees tend to place unrealistic expectations on their options and hold them in higher esteem than their value merits.
The complexity of dividing options upon divorce depends on whether the options have vested or not. If a spouse's stock options have vested during the course of the marriage, the options are clearly community property and are therefore subject to equal division. However, the situation gets more complicated when some or all of the options haven't vested yet.
California courts acknowledge that unvested options, though they have no present value, are subject to division. The manner in which a court determines what portion of the unvested options belongs to each spouse varies from case to case, and a judge has wide discretion in deciding which formula or approach to use in allocating options. In general, the longer the interval between separation and the date the options vest, the smaller the portion allocated to the non-employee spouse will be. For example, if a significant number of options vest only a few months after separation, a large portion of those shares will be considered community property. However, if a significant number of options vest three years after the date of separation, a much smaller portion will be considered community property.
In most cases, a court will use one of two formulas when determining how many options should be considered community property. Before applying one of the formulas, though, a court often determines whether the options were granted to the employee as a reward for past services, to attract the employee to the job in the first place, or as an incentive to stay with the company in anticipation of future job performance.
If the court determines that the options were granted to the employee spouse (1) as a reward for past service, or (2) as an up-front incentive to attract the employee to the job, the following formula may apply:
[(DOH - DOS) / (DOH -DOE)] x shares exercisable = community property shares
Where DOH = Date of Hire
To illustrate how this might work, let's use the example of John and Sue Smith. John and Sue live in Silicon Valley. John started working at a start-up company, TechComp, on January 1, 2010. After three years at TechComp, the CEO expressed his delight at John's performance by offering him 1,000 options, exercisable on a four-year vesting schedule. In other words, 250 of John's options vest each year. For the last three years John exercised his options in accordance with his option agreement. Because 750 shares of TechComp vested during his marriage to Sue, all 750 shares are clearly considered community property. However, on August 2, 2016, 152 days before John earned the ability to exercise the last 250 options, he and Sue separated.
Applying the formula set forth above, then, we have:
[(DOH - DOS) / (DOH -DOE)] x shares exercisable = community property shares
[(2405 days) / (2557 days)] x 250 shares = community property shares
235 = community property shares
Note that the vast majority of the shares that vest on January 1, 2017 are considered community property. This makes sense, as the reason behind granting the options (rewarding John for past performance) hinged upon his performance during the marriage.
Contrast the above formula with the approach that is used when options are granted as an incentive to keep an employee with a company:
[(DOG - DOS) / (DOG -DOE)] x shares exercisable = community property shares
Where DOG = Date of Grant
To illustrate how this formula works, and how it generates a different result, let's alter the facts in the John and Sue Smith example set forth above. This time, on January 1, 2013, after John has worked for three years with TechComp, the CEO becomes worried that John may leave, and as an incentive to keep him around, he offers John 1,000 options, vesting on the same four-year schedule.
Applying the formula set forth above, we have:
[(DOG - DOS) / (DOG -DOE)] x shares exercisable = community property shares
[(1309 days) / (1461 days)] x 250 shares = community property shares
223 shares = community property shares
Clearly the two methods offer different results when it comes to calculating the number of options that should be considered community property. In the end, if you decide to litigate your divorce, the judge will decide which method he or she prefers (or indeed, use another method entirely). If you and your spouse mediate your divorce, the two formulas can provide a reasonable backdrop for your discussions.
Of course, the analysis set forth above is only the tip of the iceberg when it comes to stock options. Stock options and other equity incentive devices come in many formats. Two commonly seen iterations include incentive stock options (ISOs) and nonqualified stock options (NQSOs).
ISOs can only be granted to employees of the underlying company and benefit from favorable tax treatment. Upon exercise of ISOs, the employee does not have to pay ordinary income tax on the difference between the exercise price and the fair market value of the shares issued. Rather, if the shares are held long enough (one year from the date of exercise and two years from the date of the option grant), the profit from the sale of the shares is taxed at the long-term capital gains rate.
NQSOs don't qualify for the special treatment granted to incentive stock options. Instead of being taxed at the long-term capital gain rate, NQSOs are taxed as income to the recipient at the time of exercise. As you might expect, this less favorable tax treatment comes with far fewer restrictions with regard to the timing of exercise.
Regardless of the nature of the equity incentives you or your spouse have earned, you should consider enlisting the help of an accountant or other executive compensation specialist in determining how the taxation of your incentives will affect their value. The IRS rules with regard to the taxation of stock options transferred between spouses upon divorce are fairly complex, and you will most certainly appreciate the help.
Spouses frequently "trade" options for other property when negotiating a divorce settlement. A spouse who has labored away at a start-up company may feel strongly about retaining all of his or her options, though this insistence on retaining all the options is typically misguided. To many employees, stock options represent a chance, however miniscule, at striking it rich - a dream that doesn't typically accompany a "boring" standard salary. Before trading the right to options for other property, it is important to get a firm grasp on options' value. Various models of valuing options exist, and when dealing with early-stage startup companies, the process is more art than science. As with deciphering the tax implications of transferring options upon divorce, enlisting expert help when valuing options will greatly ease the strain of the divorce process.
Like virtually everything else, a retirement account is considered community property to the extent the retirement benefit was earned during the course of marriage. Dividing a retirement plan is no small task, and the mechanism used to effectively split a plan varies according to the type of plan in question.
First, note that most retirement plans broadly fall into two categories: (1) defined benefit plans, and (2) defined contribution plans. Defined benefit plans are often called pension plans, and in such a plan, an employer often pays the employee a monthly sum until the employee dies. Defined contribution plans, on the other hand, often constitute a mixture of contributions by both the employee and the employer. A 401(k) plan is an easy example of a defined contribution plan. An Individual Retirement Account (IRA), while a close cousin of the defined contribution plan, stands on its own.
Valuing a defined benefit plan can be difficult simply because doing so involves actuarial calculations. In other words, the value of the plan depends on several variables, including the rate of inflation and the life expectancy of the beneficiaries. Dividing such a plan is therefore correspondingly complex. A defined contribution plan or an IRA is much simpler to value, simply because the plan administrator will report the current value of the account to holder in regular statements.
What portion of a plan is community property? A simple calculation is typically used to determine how much of a retirement plan is community property. First, the total number of months of plan participation is determined. Next, the number of months of plan participation between the date of marriage and the date of separation is determined. Finally, the first number is divided by the second to obtain the percentage ownership interest. Consider this example:
John Smith works for a manufacturing company that offers a generous defined benefit plan (a pension). He has been accruing retirement under the plan for 23 years, and he has been married to Sue for 19 of those years. The percentage of the plan benefit that is community property is therefore 83% (19 divided by 23). Sue is therefore entitled to ½ of the community property share (or 41.5%), while John is entitled to both ½ of the community share and his separate property share (a total of 58.5%).
The method has a drawback, of course, and that is the simple fact that the contributions to the plan early in employment (typically when salary was lower) are less valuable than the contributions made later in employment (when salary is large). A precise calculation may require the help of an actuary, pension administrator, or financial planner.
Sometimes spouses are shocked when presented with the actual present value of a seemingly sizeable plan. We all know that a dollar today is worth far more than a dollar ten years from now. Nevertheless, the degree to which the "present value factor" can diminish the current value of the plan is often startling. Here's an example using simplified data:
John Smith is 42 years old. Upon retirement at age 65, his plan will pay him $20,000 annually for the rest of his life. Let's assume actuarial tables state that John should live until age 75. Theoretically, then, he should receive $200,000 ($20,000 per year multiplied by ten years). Of course, John won't retire for another 23 years. Assuming a 4% inflation rate, the present value of the $200,000 retirement is only $67,000. Sue Smith is therefore surprised to learn that her 41.5% share in the plan is only worth $27,805. If she waits until John retires, she will be eligible to receive a much larger sum. Such is the nature of present value calculations.
Present value calculations can be done using present value tables, but with the internet at your fingertips, why bother? Many reputable websites offer free present value calculators that are quite simple to use (www.investopedia.com is one example).
The mechanics of retirement plan division : Dividing different types of plans requires different types of orders. Retirement plans that are controlled by federal law (which preempts state law) must be divided by an order known as a Qualified Domestic Relations Order (a" QDRO" - pronounced "quadro"). Other plans can be divided by a state court order alone. A QDRO is an extremely important document, and it must be perfectly accurate, simply because anything omitted from the order can't be reinstated later. Virtually all mediators, and most family lawyers, rely on specialists to draft QDROs.
The following table sets forth a few of the common types of plans and the type of order required.
Income tax considerations : The IRS always gets it share. True, some retirement plans have very real tax advantages, but you're fooling yourself if you don't think the IRS takes a bite of the money you accrue for retirement at some point.
A common trade-off divorcing couples agree to involves allowing one spouse to take the retirement plan, while the other retains the equity in the family home. If you are the spouse taking the retirement plan, you need to understand how the proceeds of the plan will be taxed to determine if it is a fair trade. Ideally, the retirement plan was funded with after-tax dollars, which means that you will be able to withdraw part of the proceeds at retirement without being taxed.
By either contacting the retirement plan administrator or checking your annual benefits statement, you ought to be able to determine the ratio of pre-tax to after-tax contributions. As a general rule, if your employer partly funded a retirement plan (i.e., with matching contributions to a 401(k) account, for instance) the portion that the employer contributed will be taxed when withdrawn at retirement.
Keep in mind that you do not pay taxes on money that you contribute to a traditional IRA. However, a Roth IRA works very differently. You are taxed on the money you contribute to a Roth IRA, but you receive the benefits tax free upon retirement. This clearly makes receiving a Roth IRA a more attractive proposition upon divorce.
Determining the true value of a retirement plan: The date of separation is critically important when valuing a retirement plan. As is the case with the income of either spouse, any increase in the value of the plan after the date of separation is the separate property of the beneficiary spouse. Contrast this with the way in which assets are valued - at the date of trial. This may lead to confusion, even among financial professionals. Consider the following example:
John and Sue Smith decide to divorce in 2008. John moves out of the house and rents an apartment. Neither holds out any hope of reconciliation. However, John and Sue aren't in any great hurry to get divorced, and they don't complete the process until 2012. All of the appreciation in John's retirement between 2008 and 2012 is considered his separate property. Sue is therefore only entitled to half of the value of his retirement plan as valued from the date of their marriage to the date of separation.
Calculating the true value of a retirement plan is an important part of the asset division process. It can seem daunting at first, and some people choose to have a third party (such as an accountant) value a retirement plan.
Unfortunately for many married couples, dividing debt is just as important as dividing assets. If you choose to mediate your divorce, you may divide your debt in the manner that works best for you both. If your divorce goes to trial, you won't have this luxury. The following information explores how a court might order the division of debt pursuant to a litigated divorce -- information that may help you negotiate an agreement with your spouse.
First, remember that any debt incurred during marriage and prior to separation is community property, regardless of who incurred it . This means that if your spouse secretly racked up massive credit card debt while you were married, you are out of luck. However, this is a glimmer of hope, and that involves the nature of the debt. If the debt was incurred to benefit the "community," i.e., the two of you, it is considered community property. However, if the debt was incurred solely for the benefit of one spouse, relief may be available. Consider the following example:
John and Sue Smith lived modestly. They made timely payments on their mortgage, took one inexpensive family vacation per year, and rarely ate at nice restaurants. John completely managed the family finances, from balancing the checkbook to paying credit card bills. Unbeknownst to Sue, while they were living in the same house (and separation wasn't yet being discussed), John was incurring huge credit card bills on hotel rooms and lavish meals in an attempt to impress his young lover. Sue is greatly relieved to learn that the debt associated with John's seduction of his lover is his separate property.
Note, however, that Sue's relief may be short lived. While a court can certainly divide debt and order that one spouse is solely responsible for a particular debt, credit card companies are not hindered by these orders if the credit card was a joint card. Creditors may still collect from either spouse. The only remedy for the aggrieved spouse is to go after the spouse who incurred the debt for reimbursement.
Use of community property to pay pre-marital debt : Sometimes one spouse enters a marriage with debt. If community property funds are used to pay down that separate property debt, the community is entitled to a reimbursement for the amount it paid. Consider the following example:
Sue Smith had large credit card debts she incurred prior to marrying John. To improve their credit rating so they could buy a house, Sue and John worked hard to pay off the debt. Now that they are debt free, Sue files for divorce. Because Sue and John used community property earnings to pay off Sue's separate property debt, the community is entitled to reimbursement for the amount paid. In other words, John should ultimately recover half of the amount used to pay off Sue's debt, as half of all community property is his.
Use of separate property to pay community property debt : In California, if one spouse's separate property is used to pay off a community property debt, a court will presume that a gift was made to the community. However, there is an important exception to this rule. When one spouse uses his or her separate property to acquire community property, he or she has a statutory "tracing right" of reimbursement. Such contributions include payments of principle (i.e., a down payment on a house), payments made to improve community property (i.e., an addition to a home), and payments that reduce the principal of a loan used to purchase or improve community property. Note that this does not include payments for maintenance of the property, interest on the underlying loan, or taxation. Consider the following examples:
Sue and John Smith decide to send their child, Bobby, to private school. John uses funds from his separate property brokerage account to pay the tuition. He is not entitled to reimbursement from the community for this payment.
Sue and John Smith want to purchase a home. John has significant savings that he accumulated prior to marriage. He uses these savings to make the down payment on their new home. John is entitled to "trace" this contribution to his separate property, meaning he has the right to reimbursement from the community for the amount of the down payment.
Sue and John Smith decide their home is too small, and John uses savings that he accumulated prior to marriage to "improve" the property by adding an extra room. John is entitled to trace this contribution to his separate property, and he is entitled to reimbursement from the community.
Sue and John Smith are struggling to pay all of the expenses associated with living in their home. As a result, John agrees to pay for the maintenance of the home and all associated property taxes using his separate property savings. Unfortunately for John, he is not entitled to reimbursement from the community for any of this amount. Had John used his separate property to make principal payments on the mortgage, he could trace his contribution and qualify for reimbursement. However, because John used his funds to pay taxes and maintenance costs associated with the home, he is out of luck. .
Use of separate property to pay community property debt after separation: Once a couple has separated, a spouse who uses separate property to pay pre-existing community debt is entitled to reimbursement from the community. This reverses the presumption of a gift that exists when separate property is used to pay a community debt before separation. Note, however, that there are a few exceptions to this rule. The first is that the paying spouse is not entitled to reimbursement when the amount paid is not substantially in excess of the value of the use. This may sound like a mouthful, but all it means is that a spouse who enjoys the use of the property should not be reimbursed for paying down debt associated with that property, so long as the value of the use is roughly equal to the amount paid. Consider the following example:
John and Sue Smith separate, and John continues to make loan payments on his pickup truck. Sue never drives the truck. In other words, John is the only one who enjoys the benefit of the truck. As a result, the payments John makes on his pickup truck can be correlated to his use of the truck. He is therefore not entitled to reimbursement from the community for the loan payments, even if the truck is held jointly.
There are two additional exceptions to the rule that a spouse is entitled to reimbursement for amounts paid to pay off a community debt after separation: (1) where the parties have agreed that the payments will not be reimbursed, and (2) where the payments were intended as a gift or as child support or spousal support.
Use of community property funds to pay separate living expenses after separation : The community is only entitled to reimbursement when one spouse uses community property funds to pay his or her separate living expenses to the extent that those expenses exceed a "reasonable" amount of child support and spousal support. Of course, as is the case in so many areas of the law, understanding the meaning of the term "reasonable" is important. While the term will vary from case to case, a reasonable amount would probably be the amount of guideline support that a court would order in an application for temporary child and spousal support. Consider the following example:
After separating from John Smith, Sue remains in the family home and continues to care for their son, Bobby. Sue's part-time work brings home only $1,500 a month, and as a result, a court would likely order that John pay her $3,000 per month in temporary child support and spousal support. However, Sue is waist-deep in a midlife crisis, and she soon finds herself spending $7,000 a month to support her new lifestyle. She sells $5,500 worth of stock from the Smith's community property stock portfolio each month for five months to make ends meet. Here, Sue spent $5,500 in community property funds for five months, when guideline support would have totaled $3,000 per month. As a result, a judge might order that Sue reimburse the community for the difference between guideline support and the amount of community property she liquidated (i.e., $12,500, which represents $2,500 per month for each of the five months that she sold stock).
One spouse remains in primary residence while other spouse makes mortgage payments : Quite often one spouse moves out of the family home during separation while the other spouse remains in the home. The spouse who leaves may offer to keep paying the mortgage and property taxes. Unless these payments are in made in accordance with an agreement to waive reimbursement or the payments are a form of child or spousal support, the paying spouse may be entitled to reimbursement because he or she is paying a community debt with separate property funds.
Lastly, the spouse who stays in the home could be in trouble in a contested divorce if the fair market rental value of the home exceeds the mortgage payments. If a home was recently purchased, the mortgage payments will almost always exceed the fair market rental value of a home. However, this often isn't true with older properties. A home bought twenty years ago may be encumbered by a fairly modest mortgage. However, in the intervening twenty years, the fair market rental value of the home may have increased dramatically. The spouse remaining in the home after separation may therefore be required to reimburse the community for the difference between the mortgage payments and the fair market rental value of the home between the date of separation and the date of trial. Consider the following example:
John and Sue Smith decide to separate, and they both agree that Sue should stay in the home with their son, Bobby. John continues to pay the mortgage using his income from his job. The Smith's bought their home 20 years ago, and as a result, their mortgage payments are a modest $1,500 per month. However, the fair market rental value of their home is $2,500. The Smiths separate 10 months before their divorce is final. As a result, Sue may owe the community $10,000 ($2,500 - $1,500 multiplied by 10). And it doesn't stop there. The community may also be entitled to reimbursement for the mortgage payments themselves (another $15,000). In the end, Sue will be dismayed to know that she owes a total of $25,000 to the community simply because she was allowed to remain in the home during separation. The net cost to Sue is $12,500 (because half of the community is hers, after all), and the net benefit to John is $12,500 (because half of the community is his).
The lesson here? If you are the spouse remaining in the home during separation, make absolutely sure that you document in writing that the privilege of remaining in the house should be considered an element of spousal support (or child support, if applicable) and that the paying spouse should not receive any reimbursement as a result.