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Why is the Issue of Pre-owned Assets so Important in the World of Family Law?
Why is the issue of pre-owned assets so important in the world of family law?

The issue of the equitable distribution pre-owned assets always arises in many divorce cases wherein the parties were married later on in their life, or in second marriages. If one or both of the spouses have accumulated some serious assets prior to their marriage, then some very thorny issues can "pop up" if there is a divorce. The best advice to be given to any person who has some substantial assets before he or she gets married, is to seriously consider having a prenuptial agreement signed. These agreements are not the perfect solution and they are not airtight. However, at least you might be able to sleep better at night, and not have to worry about getting "wiped out" in the event of a divorce.

Any prenuptial agreement should carefully itemize your pre-owned assets with a detailed description, estimated value, account number and/or other clear identification info. Moreover, the prenuptial agreement should also delineate not only the intended distribution of such pre-owned assets in the event of a divorce, but also the distribution of any increase in value . Finally, the agreement also should spell out whether or not either or both of the spouses should receive any credit for maintaining or paying the carrying costs such as mortgage payments or taxes for any pre-owned asset.

It is extremely important to emphasize that in those cases wherein the parties do not negotiate and sign a prenuptial agreement, then the distribution of any pre-owned assets could become a nightmare. Do you want to see your hard earned assets "vanish" before your eyes. Be smart and get a prenuptial agreement! Nonetheless, if you should choose not to have one, then it is important to keep your pre-owned assets as separate as possible from your spouse. Don't mix your pre-owned stocks, mutual funds, savings bonds, CD's, or savings account with your spouse if at all possible. In the event of a divorce, it will be much easier to keep these assets still classified as pre-owned or as premarital assets. If you "mix and match" your pre-owned assets with your spouse, then you could be creating a financial catastrophe for yourself if you should get a divorce. More than 50% of the marriages fail, so having a prenup is the right decision.

What is the black letter law with regard to the distribution of pre-owned assets?

The general black letter rule is that only assets which are "acquired" during the marriage are subject to equitable distribution at the time of any divorce. However, the legal issue of what does the term "acquired" actually encompass can take years of litigation. Moreover, many trees will have to be killed to supply the paper for the legal work to determine the answer to this legal issue. Any assets which were owned prior to the marriage are considered "acquired" during the marriage. Thus, any assets that are considered pre-owned and they are not subject to equitable distribution. Thus, your ex-spouse can't get his or her greedy hands on them.

The beginning point for any legal analysis of the treatment of any pre-owned assets in a divorce is to first develop a balance sheet of the assets which either or both parties owned at the time of the divorce. This balance sheet should include a breakdown of all of your CD's, mutual fund accounts, IRA's, or 401(k) account statements, pension statement or real estate tax records. These records should also try to establish a value of the asset as of the date of the marriage. Be forewarned though, there are many exceptions to the general rule that pre-owned assets are exempt from equitable distribution.

What happens if one spouse transfers any pre-owned assets from his individual name to the other spouse?

In many of my cases, one spouse often transfers some pre-owned assets into the name of the spouse. Many spouses make these type of transfers for tax reasons or for asset protection purposes. There are many situations wherein a spouse may transfer pre-owned assets to the other spouse to hide from creditors, and to avoid having any liens filed on any of their real estate.

While the transfer of a pre-owned asset from individual to joint names may have some advantages, there are drawbacks. To be blunt transferring assets into your spouses name could turn into a disaster and cause you financial ruin. In most instances, New Jersey law will find that there was a "transmutation" of the asset from an individual pre-owned asset which would be exempt from marital distribution into a marital asset. New Jersey law also presumes that the person making the transfer intended the other person to have a joint interest in the asset. Moreover, it is also presumed that the person making the transfer understood that by making the transfer. Therefore, it is presumed that the transferred asset would become subject to marital distribution in the event of a divorce.

Is there any way to rebut the legal presumption that a transfer of a pre-owned asset(s) was not a gift to the other spouse?

There is a significant amount of case law and legal arguments that can be made to rebut the presumption that a transfer of a pre-owned asset was not a gift. The major defense that you could raise is that the spouse never had any donative intent to make a gift. This legal issue is thoroughly addressed in my other articles. Nonetheless, it must be emphasized that this legal presumption is very difficult to overcome in the event of a messy divorce. In most divorces if there are pre-owned assets that are individually titled, or if a pre-owned asset that is transferred into joint names, then serious consideration must be given to the impact which such transfer would have upon that asset in the event of a divorce.

What happens if a pre-owned asset increases in value during the marriage?

In this day and age, given the marked decrease in value of real estate and stocks, this legal issue does not arise as often as it used to. However, once the economic recovery takes hold, then this legal issue will be prevalent once again. An often thorny issue arises when a pre-owned asset increases in value during the marriage. For example, a pre-owned home that was owned by one of the spouses before the marriage may substantially increase in value during the marriage. Moreover, any small businesses that are owned by one of the spouses before the marriage may also increase in value during the marriage. Finally, your assets such as mutual funds, individual stock holdings, brokerage account, bank accounts, or retirement accounts may also increase in value over the course of the marriage.

If a pre-owned asset increases in value how will a court analyze any increase in value of that asset?

If there is an increase in the value of the asset, then any increase in value must also be carefully analyzed. First, a critical issue is whether the increase was caused as a result of additional contributions to the account or, in the case of real estate, improvements to the property. If so, then added contributions or improvements would be "acquired" during the marriage, and thus would be subject to equitable distribution in the event of a divorce.

On the other hand, if an asset has increased in value without any added investment, then any contributions or improvements, or the increase must be analyzed as to whether it is classified as "active" or "passive." The term "active" generally means that the increase was as a result of work effort or management by one or the other of the parties. The term "passive" means that the increase in value was simply caused a result of market forces or inflation.

For example, a simple brokerage account at say AG Edwards, which was not traded, but has still increased dramatically due to a bull market force would most likely be classified as a "passive" increase. Meanwhile, if the brokerage account was actively managed, traded and controlled by both spouses, and the increase in value could be traced to other spouse's trading or financial management decisions, then any increase would likely be classified as an "active" asset.

In the case of most small businesses or professional practices, the increase in value is almost always attributed to work efforts of one of the parties. In the case of real estate, an increase in value may be a combination of inflation and market factors or as a result of the party's maintenance, improvement or upgrades to the property.

In any divorce case, it can be very difficult and expensive to accurately separate the amount of increase which is classified "active" versus that portion of the increase which is classified as "passive."

In many divorces, some typical issues arise such as:

  • How much did the home increase in value because the parties remodeled it?
  • How much did the wife contribute toward the mortgage for a pre-owned home.

Once it is determined that some portion of the increase was "active" then you must then determine which of the parties actively contributed to the increase in value. If it was the spouse who owned the assets efforts which contributed to increase in value, then the increased value is going to be distributed much differently than if it were the active efforts of the non-owning spouse.

How will a family court determine what is the amount of the increase in value of a pre-owned asset?

In most divorce cases, you will have to obtain an expert report to determine the amount of the increase of any pre-owned assets. If you pre-owned real estate before you got married, then you will have to retain a real estate appraiser. If you owned a small business before you got married, then there are companies that prepare valuation reports and appraisals small businesses. Be forewarned though, the cost to obtain these type of valuations and reports can be big bucks. It can be very difficult to go back in time and perform valuations of retro comparable sales or comparable businesses as they may have existed several years earlier, and then to extrapolate that data into a valid value which can be used for the purposes of determining the amount of increase in value.

What does the concept of "transmutation" mean?

After reviewing all of this info, it is important to emphasize that much of this nightmare can be avoided if the parties sign a prenuptial agreement. If you have a prenup, then you won't have to deal with the thorny issue of transmutation in the event of a divorce.

In addition to pre-owned assets, the subject of splitting up inherited assets often comes into play at the time of a divorce. One or both of the spouses may have inherited assets before or during the marriage. If you have inherited assets and if you are in a divorce, it is important to note that New Jersey law provides that inherited assets are exempt from equitable distribution. Therefore, the spouse who inherited his or her assets can keep them in the event of a divorce.

However, there also can be legal complications in the application of the general rule that inherited assets are not subject to equitable distribution. Suppose, for example, a spouse inherits money which he has invested in improvements to jointly owned marital home.

Moreover, suppose that one of the parties inherits money which the couple uses to pay down some credit card debt during the marriage. Another example is what if a spouse uses his or inheritance to start a small business or pay off the house.

Once again, as a general rule the legal doctrine "transmutation" also applies to inherited assets. If a person inherits money or assets which he then titles into joint names or invests into a jointly owned asset, then it would usually be assumed that they intended those funds to become marital property and that the exempt nature of the inherited asset has been "transmuted" into jointly owned marital assets which will be distributed between the parties at the time of a divorce.

Therefore, whenever a married person inherits money or assets, it is critically important for that person to make their own individual decision as to whether they intend for those funds or assets to become marital property. Alternatively, that person must decide whether they intend that they should continue to be individually owned, and exempt from equitable distribution in the event of a divorce and remains their sole property in the event of a divorce. Whichever choice a person makes, extreme care and diligence care must be taken in defining the form and nature of the ownership of the assets after receiving any inheritance.

How is the concept of "source of the funds or assets" applied during equitable distribution?

An often overlooked consideration regarding pre-owned or inherited assets is a provision in the general equitable distribution statute which provides that the "source" of the funds or assets is a relevant factor in the determination as to the distribution of that asset in the event of a divorce. Therefore, even though an asset may be "transmuted" from an individual prior owned or inherited asset into a marital asset, the fact that the "source" of the asset as it existed at the time of the divorce was initially a pre-owned or inherited asset may significantly impact the percentage of distribution which each party receives at the time of the divorce.

What is a summary as to how pre-owned and inherited assets are treated in a divorce?

In summary, any pre-owned assets, inherited assets and/or their increase in value during the marriage can become very complicated and difficult legal issues in any divorce. The most savvy advice to any person who owns substantial premarital assets is to have prenuptial agreement. These agreements are not perfect and they are not always upheld. Please keep in mind that prenuptial agreements can be set aside if there are a "change of circumstances." However, despite the fact that prenups are not guaranteed, they are much better than just walking into a marriage blind and with no financial protection.

Finally, in the event of an inheritance during the marriage, the parties must be aware of and consider the impact and various alternatives concerning the form of ownership, maintenance or control of that asset during the marriage and the impact which those various forms of ownership or control may have at the time of a divorce. If the parties acquire assets via an inheritance, then the parties may also want to consider having a post-nuptial agreement signed. This agreement can specify that the inheritance received by one spouse is not subject to any claims of equitable distribution by the other spouse in the even of a divorce.

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