Application in Divorce
Assets appreciate actively, which means as a result of improvements or actions by its owner, or passively, which means as a result of changes in the market.
Most equitable distribution states and all but one
community property state use the dual classification system in establishing the theory for the distribution of property. In this, the marital estate is divided into marital property, which is property acquired during the marriage, and separate property, which is property one spouse had before the marriage or property acquired by gift or inheritance. Property deemed marital is subject to distribution either under the doctrine of equitable distribution or community property, but a difficulty may arise when separate property appreciates during the marriage.
community property states, property is classified under the inception of title rule, which means that it is classified when the title is received, and all subsequent appreciation, regardless of cause, retains the initial classification. Inequities that result from this rule may be remedied by the equitable right of reimbursement. Under the inception of title rule, a home purchased with, for example, a $10,000 down payment by one party before marriage remains separate property even when its $250,000 mortgage was paid off with marital or community funds.
In dual-classification, equitable distribution states,
active appreciation that results from marital efforts is marital property while passive appreciation remains separate property. The burden of proof in both equitable and community property states is one the party who contends that the property is separate. Courts look on appreciation as a result of marital efforts as active, and appreciation as result of market forces or third-party as passive.
order the find active appreciation in separate property, courts must find 1) that the separate property appreciated during the marriage; 2) that the parties made marital contributions that caused the appreciation; 3) that there is relationship between the contributions and at least some of the appreciation. In the application of this three-prong test, a majority of jurisdictions have found that direct homemaker services (such as when a wife performed uncompensated direct homemaker services to a husband’s separate rental property) are indeed marital contributions causing an active appreciation in the value of the asset. In the case of indirect homemaker services, the homemaker faces the burden of proving that the indirect services aided the owning spouse by freeing him from domestic duties.
Thus, the claim of a wife who gave indirect homemaker services -- put simply, being a stay-a-home mother -- face a steeper climb.
In some states, the
burden of proof is upon the spouse who claims the appreciation is active; another group of states places the burden on the spouse who claims the appreciation is passive.
Private businesses run by
single proprietors are particularly prone to difficult questions of active and passive appreciation. In fact, active or passive appreciation can become something of a Gordian knot in the case of private business that is separate property when marital or community funds are commingled with uncompensated contributions of a homemaking spouse.
This situation happens very frequently, however.
The consideration of active and
passive appreciation can take unexpected turns. In one New York case, when a husband sold his separate property business at a very high price, a court decided that his skills as a negotiator played a substantial rule in final sale price, and it ruled that 40 percent of the appreciation was active. In a California case, a car dealership owned by a husband, "who worked short hours and took long vacations," appreciated passively.
In most jurisdictions, the appreciation of separate property as active or passive is a matter of degree because courts recognize that it happens when a variety of
factors come together in the marriage. Therefore, courts do not decided in an either/or manner but rather look to the extent to which marital contributions increased value. This can make for unexpected findings. In a 2004 Virginia case -- Courembis v. Courembis -- the court ruled that marketing, promotional and lobbying efforts on the part of wife in connection with the development of real estate added significant marital value to the husband’s separate property.
In general, in a
private company headed by a single owner all appreciation is generally active.
Some states consider the income from separate property as marital.
The management of separate property investments can become problematic when it comes to classification and division, particularly during the wide gyrations of the financial markets. When one
spouse plays an active role in the management of separate property investments, the other spouse may claim that the increase should be marital, particularly when it is the husband managing the wife’s property. By the same token, a wife whose investments take a plunge may allege dissipation because her husband mismanaged her money.
Generally, courts treat increases in the value of separate property securities and investments the way they treat the appreciation of a separate property business -- by first determining whether the appreciation is active or passive. Most dual classification jurisdictions treat active and
passive appreciation differently. Active appreciation, which results from active efforts, is normally marital property; passive appreciation, which results from inflation and normal market forces, is separate. However, substantial involvement in active management of assets owned by either spouse may make the asset marital.
Courts have held that when a nonmarital asset appreciates because of the efforts of either party, the appreciation becomes marital. The asset need not be money. In a 1991 Montana case, a court held that a wife who had managed her husband’s collection of baseball cards should share in the appreciation of the collection.
Courts are mixed in their rulings about the
active appreciation of separate property of publicly traded stocks and mutual funds as a result of the management efforts of one spouse during a marriage.
Interest income from separate property -- interest or dividends -- may become a problem, particularly in states that treat investment income as separate property but appreciation as a marital. Accumulated interest earned in a savings account -- that is, interest earned on the income of separate property -- may be marital.
Courts are mixed on whether
transmutation happens when one spouse’s separate property funds are invested in joint names.
In general, courts have refused arguments that bad investment decisions are dissipation.
One of the more difficult divorce disputes often happens when courts attempt to classify the appreciation of a nonmarital business, usually one started by a
spouse or his or her family before the marriage. Generally, courts consider three points in trying to decide if the owner spouse’s efforts in the business "count as a marital contribution." These are whether he or she received adequate compensation from the business; whether the homemaker services count as marital contributions; and who must meet the burden of proof.
When the owner
spouse receives adequate compensation from the business, the nonowner spouses faces the challenge to prove a martial contribution to the appreciation. Likewise, the nonowner homemaker must demonstrate that homemaker contributions created a marital interest in the appreciation of the separately owned business.
See also Active and Passive Appreciation; Transmutation.