The characterization of property in a divorce or legal separation case is extremely important. The distinction between separate and community property has a substantial impact on the division of assets upon divorce. The definition of separate property is any property acquired prior to marriage. The definition of community property is all property acquired by either spouse during the marriage.

During the marriage, this characterization of the property remains the same. However, the nature of the property alters when it undergoes transmutation or when an asset or debt is not clearly separate or a community. Transmutation is the transformation of something’s nature. It is the transformation of separate property into community property or community property into separate property under California family law.

When both parties seek to characterize property differently, the division of assets becomes even more complicated. For instance, one spouse may wish to designate the property as separate while the other wishes to designate it as community property.

In this circumstance, tracing separate property from commingled assets is crucial for the accurate characterization of property. It is equally important to understand what commingled assets are and how they’re separated in order to reduce the stress of this process and reach a fair result. 

This article will address the characterization of these assets as well as methods for tracing separate assets.

Commingled Assets

It’s not unusual for a married couple to combine and mix assets like bank accounts and real estate. This means that a portion of the asset belonged to one of you before you got married but got mixed in with property accrued after the marriage. In a divorce, the commingled property is neither separate nor community property and must be divided before it can be included in a divorce settlement. 

Separate property deposited in the same account as community deposits (usually in a joint account) qualify as commingled funds. An asset can qualify as “commingled” if separate property belonging to one spouse is used to acquire or purchase a community asset. 

Sorting out community assets is worth the effort because these assets won’t have to be shared. What’s yours will belong to you once again. 

Tracing Separate Property

So, how do you separate commingled assets in a divorce? There are two methods, direct tracing and family expense tracing, that have been approved by California divorce courts to trace separate property in mixed assets. 

Direct Tracing

The first method involves direct tracing. If a spouse is able to trace separate property back to its use in acquiring or improving community property, then they will be entitled to reimbursement as long as there’s no written waiver. 

With direct tracing, the separate properties within a mixed account are differentiated from each other, then the court determines if the funds were withdrawn to purchase specific property that the couple acquired based on when the funds were deposited, withdrawn, and whether or not it was that spouse’s goal to withdraw separate funds. 

In fact, separate funds do not lose their separate character when commingled with community funds in a bank account if the amount of separate funds can be ascertained. if the money is withdrawn to purchase a specific property, the question of fact that you must include:

  •  whether separate funds continue to be on deposit when the withdrawal is made, and
  •  whether the drawer intended to withdraw separate funds. 

The party seeking to establish a separate interest in presumptive community property must keep adequate records. The party must show the exact amount of money allocable to separate and community property before you may find that money allocable to separate property is not so commingled that all funds in the account are community property.

You must provide accurate bank statements from a separate property bank account that show all the expenses that were incurred to acquire or improve the community property. This may show a direct link between a separate property source and a community property purchase. 

For example, if the husband uses money from his parents’ separate property to put a pool in the community home, the forensic accounting expert will tell him he’s entitled to reimbursement. To receive this reimbursement, the husband’s family-law attorney must prove that it was purchased with his own separate funds. The court cannot give the husband a refund if he signed a waiver.

Family Expense Tracing

The second method of establishing that property purchased with commingled funds is separate property will involve tracing through family expenses. This method is useful in cases where direct tracing is not possible because of the presence of a joint bank account.

Through this exhaustion method, the spouse must prove that at the time of the acquisition or improvement, all the community funds were exhausted by community expenses, and therefore separate funds had to be used.

This method can be used only when, through no fault of the spouse claiming separate property, it is not possible to ascertain the balance of income and expenditures when the property was acquired. 

This method also refers to a situation where there are no available community funds to purchase or improve an asset. Since there are no leftover funds to purchase or improve community assets or contribute to a bank or brokerage account, the court will presume that your separate property is the only other source of funds.

Therefore, the spouse claiming separate property must keep adequate records to overcome the presumption that property acquired during the marriage is community property.

For example, if a husband cannot directly trace assets because of mixed funds and few records of how his separate property funds bought or improved assets during the marriage, the forensic accounting expert will tell him that he could trace the expenditures through the family expense presumption method, also called the exhaustion method.

According to this method, the husband must show that all of the community funds were used to pay for or exhausted by community expenses when the property was purchased.

If Community Property Cannot Be Separated

If a court finds that separate and community assets are so intermixed that it’s impossible to trace the source of them, then the entire asset is treated as community property. 

Tracing separate property in mixed assets is no easy task, but it can be made easier with the assistance of a certified financial expert who has experience in the process. We are here to help. The Certified Public Accountants (CPAs) at Miod and Company are here to help and can assist you in navigating the complexities of the characterization of property during divorce proceedings. Schedule a free consultation to find out how we can help.