No divorce is exactly the same. Each marriage has its own unique differences that will impact the elements of that particular divorce. For example, not every marriage produces children, so child support and child custody are not always at issue. Property division, also known as equitable distribution, is an element that factors in almost every single divorce. Almost every marriage will have marital property that needs to be divided between the spouses, so property division is a consideration in a majority of divorces.
All marital assets are not created equal. Some marital assets are very easy to value and divide between the two parties. Other assets are more challenging in both valuing and division. We will start with discussing the process of property division before discussing how to value and divide more challenging assets.
The Process
The courts complete four different steps when distributing marital property in a divorce. Assets and debts, also known as the marital property, are the only things to be distributed to both parties.
- Identify: The parties will bring evidence to court about all their assets, property owned, and debts, money owed. The court then goes through all the property and evidence provided to see who might have an ownership claim to the different assets and debts.
- Classify: Classification is a more technical legal process. Basically, the court goes through each property item that was identified by the parties because they believe they have an ownership interest in the item and the court applies the statutory definitions of marital property and separate property. During the classification, the court’s decisions are required to have support of both evidence and the correct findings of facts in the court order.
- Value: The date of the separation of the parties is the date used by the court when determining the net value of the property considered marital. The formula used to determine net value is: Market Value – Encumbrances = Net Value. The net value is then the amount that will be divided between the spouses by the court.
- Distribute: The last step is the distribution of the marital property by the court in an equitable manner. The Equitable Distribution Act requires that the marital property be equally divided, unless the court determines that equal distribution would end up being inequitable. The court’s distribution cannot be reversed except if the court had abused its discretion when dividing the property.
The process appears to be easy: identify, classify, value, and distribute. Sometimes, the process is straightforward. Consider the following example: a husband and wife bought a $500,000 house while married. The house would be considered marital property with both spouses entitled to $250,000, or half the value of the home. There is no question that the house is marital property and it’s not difficult to assign its value. If there are ever questions about the value of a home, courts look to the tax value or have an appraiser provide an appraisal value.
Separate Property Improvements
Questions come up when one spouse comes into a marriage with separate property but marital funds are used to make improvements. Joe bought a house is 2008. In 2010, Joe and Jamie married. Between 2011 and 2014, they used marital funds to make significant improvements on the home and surrounding property. At the end of 2015, Joe and Jamie separated. Joe was the one who originally purchased the home for $150,000. Because of all the improvements made with marital funds, the house is now worth $250,000. Is Joe entitled to the entire value of $250,000 because the house originally belonged to him? No. Joe is not entitled to the entire current value of the home.
Active v. Passive Increases
In the example above, the law protects Jamie as the party that helped improve the property despite not being the owner. Active increase in the value of an asset that happens during the course of the marriage is considered to be marital property. Using Joe and Jamie’s situation from above, the original $150,000 of Joe’s is separate property. The $100,000 increase in value because of the improvements paid for with marital funds would now be considered marital property and would be distributed between Joe and Jamie.
Active increases can also be the result of the parties making improvements themselves instead of paying someone to make the improvements. The idea behind this is that the individuals were physically improving the property and took time away from work, their marriage, etc. to make those improvements. Therefore, the active increase in the value of the property is marital property.
Now let’s compare the active increases in the examples above to passive increases in value. Joe’s house was originally purchased for $150,000. The house is now worth $200,000. The increase in value is because of the market, not because improvements were done to the property. Because the increase in value was only due to market fluctuations, that passive increase belongs solely to Joe. Joe is entitled to the entire new value of the home, $200,000.
Mortgage Payments for Separate Property
Let’s go back to the example of Joe and Jamie. The example assumes that when Joe purchased the home, he paid in cash and does not have a mortgage. Now let’s change the situation up. Joe purchases the home with a down payment and financed the rest of the purchase with a mortgage. When Jamie marries Joe, they move into the home and Jamie’s income helps to pay the monthly mortgage payments. The mortgage payments are paid using marital funds throughout the entire marriage until Jamie leaves the home.
Because marital funds were being used to pay off the mortgage, Jamie would be entitled to part of the equity in the home. The five years of mortgage payments increased the home’s equity by $50,000. Joe would owe Jamie $25,000, half of the increase of the equity of the home. While these calculations are more complex in realty, the calculation above is just to illustrate the general idea of how the process works.
Mortgage Payments Post-Separation
What about situations where one spouse continues to make mortgage payments on the house that the other spouse continues to live in, after the date of separation? When Jeff and Cindy separated, Cindy remained in the marital home and Jeff moved out. Jeff continued to make the mortgage payments despite Cindy being in exclusive control and possession of the home.
Jeff has continued to contribute to the equity of the marital home, despite the fact that he is not able to use or possess the home. Jeff’s payments would increase the equity of the home. It appears to be unfair that the value of the home would be split between Jeff and Cindy evenly based solely on the fact that the home is marital property.
If only a few mortgage payments were made, this could potentially be a non-issue. It would be unlikely that the payments made any real increase in the equity of the home. But, if Jeff was making payments for years before an agreement on equitable distribution was made, the payments potentially increased the equity of the home significantly.
Judicial Discretion and Distributional Factors
In a situation where one spouse is continuing to make post-separation mortgage payments and the other spouse continues to reside in the home without making mortgage payments, the court is able to consider the payments as a distributional factor. The court is able to consider the payments Jeff made when they are settling the estate. It is important to know that Jeff may not get the exact dollar amount back that corresponds with the equity increase of the property because of his mortgage payments
The judge is allowed to consider post-separation mortgage payments as a distributional factor under the law. But, the judge has discretion in whether the payments should be considered. This means that if the judge does not think that the post-separation mortgage payments should be considered, the judge can disregard the payments. The judge can also have the non-paying spouse reimburse the paying spouse by doing an inequitable distribution of assets.
It is important to remember that the judge has discretion in deciding how to handle post-separation mortgage payments and that the payments could potentially impact the property settlement.
Business Interest Valuation
Another issue that comes up is placing a value on a business interest. In equitable distribution, placing a value on this type of asset can be tricky.
Valuing items within the business can range from easy to difficult. Real property is easier to value. It can be valued by ordering an appraisal or by going by the tax value of the property. The parties can argue over the exact value of real property, but even if two different appraisals are done, the value will be close.
Vehicles fall into the easy category. You would look up the fair market value of the vehicle with Kelley Blue Book. Bank accounts, retirement accounts, and similar accounts would fall into the easy to value category. You look up the value of each account on the actual date of the separation.
In contrast, items like furniture, jewelry, electronics, and keepsakes are harder to value. A party’s business interest is an asset that is considered to be extremely difficult to value. Because of the difficulty in valuing some assets, it is important to have it done correctly, as evidenced in the example below.
Undervaluing Your Business Asset
The next example outlines why it is so important to be aware of business interest when you are dividing assets between the parties and what can happen if a business asset is undervalued by a spouse. A young couple decided to divorce after several years of marriage. The family did not appear to have a great deal of money. The husband was part-owner of a software company with an annual income of $55,000. The wife stayed home with their young child. Overall, the divorce was amicable. Both the husband and wife completed financial affidavits. The husband claimed $45,000 as his interest in the company as an owner. Based on the financial affidavits, the husband was ordered to pay the wife $125,000 to divide the marital property equally between both parties. This settlement included the wife’s portion of the husband’s interest in the business.
What the wife didn’t know was that her ex-husband had significantly undervalued the software company in his affidavit. Six months after the divorce was finalized, the company sold for million dollars and he received a substantial multi-million-dollar payout. The husband knew that his interest was worth more than what he put on his financial affidavit because the company had received many comparable purchase offers prior to the finalization of the divorce. The wife did not suspect that her ex had been deceitful in his financial affidavit and that the amount he claimed was just a very small percentage of the actual value of the ownership.
When the sale of the company was reported in the news, the wife claimed fraud in her lawsuit against her ex. A lengthy legal battle ensued before they were able to come to an amicable settlement. The legal fight costs both parties a fortune in both legal fees and expert witness fees. After all the fees were paid, only $300,000 remained of the wife’s settlement.
Avoiding Costly Mistakes
The individuals can determine who they want to value their business. It can be simple or very complex depending upon the type of business and what the parties prefer. When a business interest is very small, the parties are not disputing the value of the business, and both parties are willing to agree to the value during the division of the marital property, the parties themselves value the business interest. Attorneys are able to value a business when the interest in the business is small and less complex. It is important to note that the attorney for the owner of the interest will place a lower value on the business interest compared to the attorney for the party without the ownership interest, who will argue that the business is worth more.
Experts are brought in to value business interests when research needs to be done in regard to the businesses history, finances, assets, and liabilities. Experts use the three different approaches noted above when estimating the value of the interest. The most common experts used are Certified Business Appraisers (CBA) and Accredited Senior Appraisers (ASA). Occasionally, a Certified Public Accountant is brought in to assist with the valuation. The case attorney will complete the referral if an expert is required for the case.
In some cases, both parties hire their own, independent experts to value the business interest. This is typically reserved for cases where monetary value in question would be very high. The experts will research and value the business for their client in what is called a “battle of the experts.” If the parties are not able to negotiate the business interest, both experts would testify to their valuation and the judge will determine value after hearing all the evidence.
The most important thing to consider in regard to a “battle of the experts” would be the increase of legal fees. The cost of an expert is an additional fee that increases depending upon how complicated the valuation is. Additionally, the attorney fees will increase because the attorney will need to take additional time to learn and fully understand the analysis of the expert in order to be able use the expert’s valuation to benefit their client. When determining if hiring an expert is worth the increased legal fees, look at the potential value of the asset. If the business interest is small, it is generally not worth the increased legal fees. If the business interest is significant, it would mostly likely be worth the legal fees to hire an expert.