Calculating the Community’s Interest in a Separate Property Asset

A transmutation of property occurs when the spouses agree to change the nature of the property. For example, suppose Henry owns a house, classified as his separate property, located in Corona, California. Henry decides he wants to share this property with Wendy and give her a legal interest in the property. In this example, Henry wants to change to the nature of his house from his separate property to community property. In order to validly transmute the property, or change the nature of the property, Henry must execute a written document according to the specifications of the Family Code.Without this written document, the nature of property cannot change from separate to community property. So, if Henry tells Wendy “I would like the Corona house to be our community property,” this statement alone is not a valid transmutation. There must be a writing that confirms the intent to change the nature of the property.In certain circumstances, the community can develop an interest in a separate property asset; however, despite this newly acquired interest, the nature of the property does not change from separate property to community property. That is the fact situation of Marriage of Moore.As discussed above, without an agreement otherwise, separate property remains the property of the separate property holder. In some instances, however, the community may acquire an interest in the separate property. In Marriage of Moore, Lydie Moore, prior to marriage, purchased a house in her name and acquired a mortgage for that property. Additionally, she made a down payment and began to repay loan. This occurred prior to her marriage to David so both the house and the loan are classified as Lydie’s separate property.After David and Lydie married, they moved into Lydie’s house and made payments on Lydie’s mortgage using community property funds. During this time, the house appreciated in value. When the couple separate and moved for dissolution of marriage, David argued that the community acquired an interest in the property and that the community should be compensated for this interest in the property.The Court agreed, however, it had to decide the extent of the community’s interest in the property. Ultimately, the Court decided that the community’s interest is based on the amount of community funds used to reduce the total purchase price. Additionally, the Court decided that community funds used to pay interest on the loan and taxes would not be included to calculate the community’s interest in the property.To illustrate the Court’s decision, I will use the marriage of Henry and Wendy. Assume that in 2000, prior to marriage, Wendy purchased a house in Rancho Cucamonga. The purchase price of the house is $100,000. Additionally, she secured a mortgage in her name and put $20,000 down. By 2003, Wendy paid a total of $10,000 in payments. In 2005, Wendy and Henry marry. The couple decides to live in Wendy’s home. After marriage, the couple pays $10,000 in mortgage payments. In 2010, Henry and Wendy file for dissolution of marriage. At the time of divorce, the property is worth $150,000.The house in Rancho Cucamonga is indisputably Wendy’s separate property because Wendy acquired both the property and the loan prior to marriage, using her own funds and credit for the mortgage. The community acquired an interest in the property because community funds were used to pay mortgage payments. The court must, however, compensate the community for the interest it acquired by making mortgage payments. Effectively, the community will receive the monetary value of its payments and proportional share of appreciation of the property. It takes several steps to calculate the community’s interest.Step One: Calculate the Community’s InterestTo calculate the community’s interest the court will divide the purchase price, here $100,000, by the total amount of community funds used to pay the mortgage, here $10,000. Thus, the community’s interest is 10% and Wendy’s separate property interest is 90%.Step Two: Calculate the AppreciationAdditional calculations are needed to determine the monetary amount each spouse receives. First, we have to calculate the appreciation of the property. To calculate the appreciation one must subtract the fair market value of the property at divorce from the original purchase price. The fair market value of the house at divorce is $150,000. The original purchase price is $100,000, thus the appreciation is $50,000.Step Three: Calculate the Amount of Compensation to the CommunityFirst the court must multiply the community’s interest by the amount of appreciation. Here the totally community interest in the appreciation is $5,000 (10% community interest times $50,000 the appreciation amount). Next, the court will add the $5000 to the total community contributions to mortgage equal. Here the community contributed $10,000 so the community’s interest in appreciation plus its total contributions to the mortgage equals $15,000.Therefore, the total community interest in the property is $15,000. Each spouse is entitled to half of the community property, so Henry will receive $7,500 and Wendy will receive $7,500.Wendy also receives the remaining value of the house as her separate property and the remaining amount of the mortgage is assigned to her as her separate debt.The Court in Moore specifically excluded taxes, insurance payments, and interest payments from its calculations. The Court reasoned that taxes, insurance payments, and interest payments are merely expenses and do not enhance the value of the property. Owners derive value from the property due to its equity; because these expenditures do not enhance the value of the property they are not to be included in the calculations of the community’s interest.While the nature of property cannot be changed without an agreement, it is possible for the community to develop an interest in a separate property asset. If community funds are used to pay the debt incurred for a separate property asset, such as a house, the community earns an interest in that property. The interest earned is reflected by proportion of community funds used to pay the original purchase price compared to the actual purchase price.Additional calculations are used to reflect the appreciation of the asset. Thus, the monetary value assigned to the community includes both the money used to pay the debt and proportional amount of asset appreciation. Finally, taxes, interest payments, and insurance payments are mere expenses and not to be included in the calculations.

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