Yours, Mine and Ours – Applicable Asset Tracing Methods in a Divorce Matter

“What’s mine is yours” — unless there is clear and convincing evidence to the contrary. Property (such as checking and savings accounts, retirement accounts, investments, business interests, real estate, vehicles, furniture, jewelry, etc.) acquired prior to and during a marriage can fall into the following categories in the event of a divorce: yours (separate property), mine (separate property), and ours (marital/community property).

Marital/community property consists of all income earned and all property acquired with that income during the marriage. This property is to be divided equitably between the parties in the event of a divorce. Separate property, on the other hand, consists of all property owned prior to the marriage or obtained during the marriage via gift, inheritance, or bequest. For assets to be classified as separate property, the party making the separate property claim carries the burden of proof to support that claim. If the asset can be clearly characterized as separate property, it will not be subject to division with the other spouse and will be allocated entirely to the separate property owner.

If separate property has been commingled (or mixed) with marital/community property, a tracing analysis may be necessary to track the separate components of the asset over (1) the period of the marriage or (2) the time since the asset was received. There are a variety of methods/approaches that can be used to trace assets in a divorce matter are described below.

1. Direct Tracing

The direct tracing method involves tracing separate property from its inception through the present. For example, Jane Doe may provide account statements for an inherited account claimed as separate property that document the receipt of the inherited funds and the activity in the account since that time. Further, if funds from that account were used to purchase a home, Jane Doe may provide documentation of the transfer of funds out of the account and the related documentation for the purchase of the home in order to claim the home as separate property as well.

2. Exhaustion Method / Family Expense Presumption Method / Community Out First Method

This method, which goes by various names, assumes that marital/community funds are used to pay for any marital/community expenses before these expenses are covered by separate funds. In other words, for a commingled account, the separate funds sink to the bottom and the marital/community funds are assumed to be withdrawn first.

For example, assume an inheritance check of $10,000 (with proper evidence of being a separate asset) is deposited into a joint account. The joint account also contains marital/community funds of $20,000. Over time, $22,500 is withdrawn from the account for living expenses. The remaining $7,500 in the account would be deemed separate property under this method.

3. Minimum Sum Balance Method

Under this method, if separate property deposits are identified and the balance of the account never drops below the sum of those separate property deposits, those contributions are deemed to still exist in the account and are characterized as separate property. The party with the burden of proof will need to document that the balance of the account never fell below the amount claimed as separate property.

4. Clearinghouse Method

The clearinghouse method of tracing is utilized when separate property funds are temporarily deposited into a community (joint) account and then withdrawn. The assumption is if specific separate property is deposited and then a similar sum (or the same amount) is withdrawn shortly after, the withdrawal amount is characterized as separate property.

For example, assume John Doe receives a gift of $20,000 from his parents and deposits the gift into a joint bank account on January 1. On January 25, John Doe withdraws $18,000 from the joint account and deposits it into a new separate account. Under this approach, the new separate account would be considered John Doe’s separate property.

5. Pro-Rata Approach

The pro-rata approach is utilized when a marital/community account or asset receives a contribution of separate funds. From that point forward, the percentage of the account that is comprised of separate property is assumed to be maintained going forward for any cash outflows. In other words, if funds are withdrawn from the account, the composition of the withdrawal would be pro-rata in proportion to the respective balance of the separate property and community property funds at that time. If additional marital/community deposits or separate property deposits are made, that would again change the percentage mix between marital/community and separate property. This approach removes the need to analyze the character of each withdrawal from the account.

For example, assume a joint account with a marital/community balance of $10,000 received a separate property inheritance deposit of $40,000. At that point, 80% of the account would be deemed separate property ($40,000/$50,000) and 20% would be deemed marital/community property ($10,000/$50,000). If a withdrawal of $10,000 was made, it would be deemed to be comprised of 80% separate property and 20% marital/community property. If the account appreciated in value by $5,000, the same 80%/20% split would hold to allocate that gain between the separate and marital/community buckets.

It is important to note that the tracing methodologies utilized are often driven by the extent and completeness of the information available. Proper documentation is key to tracing separate property. Depending on the complexity of the analysis, financial experts are often engaged to perform the tracing.

Ideally, property owned before marriage and gifts/inheritances received during the marriage should be kept in separate accounts (isolated from any marital/community property). However, it is not the end of the road if separate property was commingled. The tracing methods outlined above may be used to satisfy the burden of proof necessary to characterize commingled property as separate.