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The Basics of Tracing


When parties divorce all of the "community property" is generally divided equally. However when there is "separate property" then that amount of separate property typically remains the separate property of the spouse who obtained that separate property in the first place. There are times when one party brings separate property, property acquired prior to marriage for instance, into the marital estate. This separate money sometimes gets mixed in together with the marital couple's community property. Upon divorce, the owner of the separate property often times doesn't want to split what would otherwise be community property with his or her spouse. Thus it is incumbent upon the party wishing to protect the separate nature of his or her property to "trace" out the property to show what funds the property initially came from. If the property initially came from separate property then it can remain separate property if it can be traced thoroughly to show that. If it cannot be traced back to separate property then the property will be considered "comingled" to such an extent that its nature is transmuted into community property and thus subject to equal division.

It is important to understand what methods your state courts allow for the purposes of tracing. Keep in mind that if a separate property asset has been moved many times or held for long periods of time it may likely require an expert to perform the tracing function. On the other hand if separate property only moved a limited number of times and the records are easy to obtain and understand then an expert may not be crucial. The most comprehensive form of tracing is "direct tracing". Direct tracing requires detailed and comprehensive records of all transactions in and out of commingled accounts. It is necessary to have records from the time the original asset was acquired through the date of divorce. Each deposit and each expenditure should be recorded. If tracing proves impossible at any point in the asset's history then the asset will likely be transformed into community property subject to equal division.

Unfortunately, direct tracing is not easily accomplished. This is especially the case with longer marriages and marriages with many moving financial parts. The reason for this is that many records are not retained. Bank, business, and personal financial records tend to be lost over time. As soon as these records are lost, discarded, or destroyed the financial picture cannot be put together so as to connect all links in the chain. Given these obstacles, many courts are inclined to allow other methods of tracing. Many courts will allow an expert to opine to a reasonable degree of accounting certainty that such property is separate property. Accountants, using Generally Accepted Accounting Principles (GAAP) have developed various methods of tracing out the separate nature of what might otherwise be community property.

One of these methods is "the family expense method". This method assumes that in a commingled account, family money will be used to pay family expenses before separate money is used for the same. Thus, to calculate the amount of separate property in an account one need only look at all the community "family" money that went into the account and then calculate all the community "family" money that went out of the account. If more family money went out then family money that went into the account then the remaining balance is all separate property. If more family money went in than family money went out then all excess money that went in that wasn't separate remains family money while all the separate property money already in the account remains separate. The "family expense method" looks both to where the money came from as well as what the money was spent on.

Another method, the "Martial Assets Out First" method is similar to the family expense model though is different in that under this model we don't look at what the money was spent on. Under this model it is presumed that marital money is always spent first before separate money. In other words, separate funds stay on the bottom of the account until all marital funds have been spent. The "total recapitulation method" relies on a simple equation. The method looks at how much total marital income was received during the marriage as well as to what the total marital expenses were over the course of the marriage. To the extent that marital expenses exceed martial income we know that that excess amount of expenditure was purchased with separate property. Under the "pro rata" method we establish a percentage of separate property in a commingled account over time. That percentage is then applied to an asset in question, the balance of the account, or both. So any assets purchased during the same period of time as the account was active, and purchased from monies in that account will have the same ratio of separate to community property as that of the account itself.

Remember that in your state if you wish to show that the asset is separate and not community you will likely have the burden of proof. If you cannot meet your burden then the asset will be presumed community. Given this burden, you will likely need an expert to testify to a reasonable degree of professional certainty that such asset is in fact separate property. Given the fact that GAAP and GAAS analysis are reliable enough for fortune 500 corporations they should be sufficient to prove the nature of a marital asset in divorce. Understand what approaches and what burdens apply in your state. Then determine whether you will need such expert.

For more information on this subject I direct you to Miles Mason, Sr.'s work. He is a JD and a CPA and has written thoroughly on these subjects. Most of my learning such as the information provided above comes from his mastery and writing on the subject matter.

Categories: Family Law