A very common scenario arises in many divorce cases, where one of the spouses enters into the marriage owning a residence which remains in that spouse’s name after the marriage. The question frequently arises of what if the loan balances is reduced during the marriage.
Does the house become community property because the earnings of one or both of the spouses are used to pay down the margate? Or, does the spouse who’s name is on the title get all of it? The following hypothetical case will explain how this is resolved.
John and Sarah are getting a divorce. John owned a single family residence before the marriage, and the title remained in his name throughout the marriage. However, during the marriage John and Sarah used their earnings to reduce the principal balance of the home loan.
In their divorce case, Sarah acknowledges that her name was never put on the title. However, Sarah’s attorney asserts that Sarah is entitled to a share of the home’s equity because community property earnings that were used to make the mortgage payments during the marriage. Predictably, John rejects Sarah’s claim on the basis that the home was his separate property and Sarah’s name was never put on the title.
Who wins?
Initially, in order to answer that question, we need to first understand that community property is defined as anything that is acquired by a married person, between the date of marriage and the date of separation, except if it derived from a gift or inheritance. Because their earnings did not come from a gift or inheritance, John and Sarah’s earnings were clearly community property Sarah was the winner because community property monies, i.e. John’s and/or Sarah’s earnings, were used to reduce the outstanding balance of the home loan on John’s separate property residence.
Two important California appeals cases, Marriage of Moore and Marriage of Marsden, have held that the community estate acquires an interest in the separate property residence of a spouse, to the extent that the community property earnings of either spouse were used to make mortgage payments, during a period when the home was appreciating in value. Those cases draw a connection between the reduction of the loan balance during the marriage and the creation of a community property interest in what is one spouse’s separate property residence.
The following example shows how the “Moore/Marsden Rule” is applied.
First, assume the following facts:
- John purchased the residence for $500,000 five years before the marriage.
- As of the date of marriage, the loan balance was $425,000
- The home was worth $700,000 as of the date of marriage.
- The mortgage balance was $350,000 when the parties separated.
- The home was worth $900,000 on the date of trial.
- The mortgage balance was $300,000 as of the date of the trial.
- The home was worth $1 million as of the date of the trial in court.
Second, the following steps then have to be followed to determine the community property share of John’s residence:
| Step Number | Description | Calculations | ||
| 1 | Determine the amount by which the community property payments (typically, payments made from the date of marriage until the date of separation) reduced the principal on the mortgage.
|
$425,000
– $350,000 $75,000
|
Loan balance at date of marriage
Current loan balance Marital reduction of loan balance |
|
| 2 | Calculate the community property percentage share by dividing the amount determined in step one by the purchase price. | $75,000
÷ $500,000 15%
|
Marital reduction of loan balance
Purchase price Community property percentage of loan reduction |
|
| 3 | Determine the appreciation in the value of the house during the marriage (i.e., from the date of marriage until the date of separation). | $900,000
– 700,000 $300,000 |
Current fair market value
Fair market value at date of marriage Appreciation during marriage |
|
| 4 | Multiply the appreciation during the marriage (the amount determined in step three) by the community property percentage share (the percentage determined in step two) to determine the community property share in the appreciation of the property.
|
$300,000
x 15% $45,000 |
Appreciation during marriage
Community property percentage of loan reduction Community property share of appreciation |
|
| 5 | Add the marital reduction of loan balance(the amount determined in step four) to the amount of community funds used to pay down the principal on the mortgage (the amount determined in step one) to determine the total community interest in the residence. | $75,000
+ 45,000
|
Marital reduction of loan balance
Community property share of appreciation Total community interest |
|
| 6 | Subtract the total community property interest from the current fair market value of the residence | $700,000
– $120,000 $580,000 |
Current equity
Total community interest John’s separate property interest |
|
Thus, the community property share of John’s residence is $120,000. Sarah’s one-half portion of that share is $60,000. This means that the $700,000 of equity ($1 million minus $300,000) in the residence must be divided as follows:
| To John: | 60,000 | John’s portion of the community property share |
| +580,000 | John’s separate property portion of the equity | |
| $640,000 | John’s total | |
| To Sarah | $60,000 | Sarah’s total |
This analysis is not limited to single family residences. It is fully applicable to any other asset that has appreciated during the marriage.
