White v. White - Is Appreciation Separate or Marital Property?
When dividing property in a divorce case, courts in most states distinguish between separate and marital property. Generally, separate property isn’t subject to division, while marital property is. Separate property may include property a spouse brings into the marriage (that is, property he or she owned before getting married), as well as property received by a spouse during marriage by gift or inheritance, or through an award from a lawsuit.
The distinction between separate and marital property is less clear when the value of an asset that’s classified as separate property increases during the marriage. That appreciation may be considered marital property in certain situations, which can have a significant impact on the division of property in divorce.
Active vs. Passive Appreciation
When classifying appreciation on separate property for divorce purposes, many states distinguish between active and passive appreciation. Active appreciation — appreciation because of the efforts of one or both spouses — is generally treated as marital property subject to division. Passive appreciation — attributable to external factors such as inflation, market forces, regulatory changes, and the efforts of others — is usually classified as separate property.
This distinction can be complex in practice, however. Some assets generate only passive appreciation, such as a certificate of deposit owned before marriage that earns a fixed rate of interest. But certain assets can generate a combination of active and passive appreciation.
Case in Point
In White, the spouses disagreed about how to classify the appreciation of an investment account. The husband, a financial advisor, had opened the account with his separate property, a $100,000 inheritance. He allocated the investments using modern portfolio theory — the same approach he used for his clients — and reinvested the earnings each year. Five years later, when the couple divorced, the account was worth well over $300,000. The husband asserted that the increase in value was passive appreciation and was, therefore, separate property.
But the Nebraska Supreme Court rejected this argument, because he failed to prove that some or all of the appreciation wasn’t attributable to his or his wife’s efforts. The court listed several examples of evidence that could have established the growth in value was attributable, at least in part, to passive factors, including:
- Evidence of some benchmark of general market growth,
- Evidence that some or all of the annual rate of return was guaranteed or statutorily prescribed, and
- Evidence that he relied on recommendations from or management by a third party.
In contrast, the evidence showed that his efforts in employing modern portfolio theory — evidence of active appreciation — contributed to the account’s impressive returns. Therefore, the court found that the appreciation was marital property that should be included in the marital estate and subject to division.
Note that state laws and legal precedent vary significantly from jurisdiction to jurisdiction; so, it’s important to consider state statutes and case law in the proper jurisdiction. However, family court judges may sometimes look to other states for guidance on how to value marital assets, especially when there’s not much relevant precedent in a case’s venue.
Experts Add Value
It’s common for investment portfolios and private business interests that start out as separate property to have elements of both active and passive appreciation. A business valuation professional can help the parties allocate appreciation between the two categories based on the facts of the case.