By Chrissie A. Powers, CPA/CFF, CFE, CVA
Separate property, which is not included in the marital division, may include: property acquired by a spouse before marriage, property received in exchange for separate property, compensation for personal injury, gifts made to only one spouse and inheritances obtained by only one spouse. For example, Husband receives a gift of 2,000 shares of Microsoft stock from his grandmother during his marriage. If Husband still has the same 2,000 shares of Microsoft stock during the divorce process, Husband has a claim for separate property. In this situation, the tracing is quite simple; however, it becomes more complex if Husband sells the stock, deposits the proceeds into a joint checking account and months later decides to use the money as a down payment on a house. Where is Husband's separate property? How much is Husband's separate property worth? Financial experts regularly trace separate property in cash accounts, retirement accounts, investment accounts and real estate.
The attorney will generally approach the financial expert stating that his client has a separate property claim on a specific asset. The financial expert will then discuss what records, which vary depending on the asset, will be needed to validate the separate property claim. For example, if the separate property claim is on real estate, the financial expert would need the following documents if applicable: settlement statements, loan documents, mortgage statements, line of credit documents and statements, bridge loan documents, appraisals on the real estate, detail to support any improvements made on the real estate, and documents related to any type of refinances. These records will need to be supplied from the date of marriage (pre-marriage date) or date gifted until the valuation date, with limited to no gaps in record sequence.
Tracing separate property can be tedious and time consuming. Once initial records are provided, a preliminary review would be done to determine if all of the records were produced. If records are missing, the client would need to determine whether these records are obtainable. If all or enough records are obtained, the financial expert can begin preparing their separate property tracing schedule. A general template may be used to preliminarily lay out how the schedule is to flow, but always needs tweaked to fit each case, as no case is exactly alike.
Often times separate property funds are commingled with marital funds and the separate funds need traced through the commingled bank or investment account. The separate property funds or stock being deposited must be validated coming into the account and can quickly turn into multiple tracings.
In tracing separate property, it is important to "follow the money." In the above example where Husband inherited stock, the stock was sold, turned into cash, the cash was deposited into a joint checking account and then ultimately invested into real estate. The separate property is now located in the house. There is an argument that since the proceeds from the sale of the stock went into a joint checking account the proceeds are no longer distinguished from the marital funds and therefore loses its separate property status. However, the other side of that argument is that if Husband's stock proceeds were $50,000 and the balance in the joint checking account was $50,000, before the proceeds were deposited for a total of $100,000, than half the account holds separate property and half the account holds marital property.
If real estate was owned prior to a marriage or gifted during the marriage and no marital funds were used on the property (i.e. mortgage payments or improvements), the tracing may be straight forward. However, when marital funds are used on the property, the tracing becomes more complicated. The tracing should incorporate separate property, marital property, and the related appreciation/depreciation. Another issue that the expert may have to consider is improvements made on the real estate which are funded with separate property. The separate funds spent on the improvements would increase the separate percentage of ownership within the real estate.
These are simplistic approaches and may vary depending on the approach by the financial expert. There are exceptions to these rules and rarely are two cases ever the same. If you have any questions or would like to discuss tracing in more depth, please contact us at 614-745-5192.