The “Wild West” of Divorce Law Concerning Real Estate in Virginia

For many years, the courts and bar have been trying to figure out the best way to equitably (i.e. “fairly”) divide and distribute the equity value of a divorcing couple’s residence (and other real estate) when there has been a commingling of marital and separate (non-marital) funds[1]. Once property has been “commingled”, it is usually looked upon, by Virginia Courts, as “hybrid property” (part separate, part marital property). Hybrid property questions, when it comes to the marital residence and real estate in general, often arise in the following situations:

• If one party uses his or her pre-marital cash as the down payment on the marital residence, does he or she get that money back when there is divorce?
• If the party making the down payment, out of premarital money, is to get that money back in a divorce, is there a fair calculation available to figure out how much that original down payment is worth today?
• How is money earned during the marriage, which is used to pay the monthly mortgage bill (plus homeowner’s insurance and real estate taxes) accounted for when the equity value of the marital residence is divided and distributed in a divorce?
• How are improvements to the marital residence accounted for?
• What is the effect on the division and distribution of the equity in the marital residence, upon divorce, if one party uses his or her separate (non-marital) funds to pay for improvements to the residence?
• What happens when one party owns a home prior to the divorce, which is then utilized by the parties as their marital residence and, while the parties are married, the mortgage, etc. is paid for out of the parties’ marital income (e.g. salary money)?

Historically, lawyers, judges and the moneyed-client (the party who made the contribution of his or her separate assets into the marital residence) are focused on a determination of the value of the separate assets which were contributed toward the acquisition and improvement of the real estate and, often, a reimbursement of that sum at a “fair present value”. More recently, however, there has been a trend toward quantifying and giving financial credence to marital contributions (usually in the form of income earned during the marriage) even when those marital contributions did little to pay down the mortgage principal (i.e. when the marital contributions went primarily toward the payoff of interest on the mortgage, homeowner’s insurance and real estate taxes).

SOURCE OF FUNDS: This area of the law is often determined based on the concept of “source of funds”. In essence, courts often emphasize where the funds came from that paid down the principal on the real estate (e.g. Inheritance? Money earned prior to the marriage? Profit from the sale of other pre-marital real estate? Pre-marital savings?).

PRINCIPAL versus INTEREST: In many cases, the commingling of separate and marital assets comes about when one of the parties makes a down payment on the couple’s marital residence out of his or her pre-marital (separate) assets. That down payment is a direct pay down on the mortgage principal. Over time, that same couple may pay thousands of dollars toward paying off the mortgage note (and real estate taxes and homeowner’s insurance), but courts sometimes negate those contributions unless and until those marital contributions begin chipping away at the principal. This is why some attorneys refer to much of the value of the monthly mortgage payments, in a divorce situation, as “merely paying rent”.

RISK FACTOR & HARD WORK: The “principal versus interest” approach, however, is losing favor in Virginia courts. Lawyers and judges, these days, are paying more attention, and giving more financial credence, to risk factors (putting your credit on the line) and hard work (earning the money to pay the bills) when dividing and distributing the equity value of a divorcing couple’s marital residence. Attention is being paid in Virginia courts to many “risk and hard work” factors, such as:

 The husband and/or wife’s good name/good credit necessary to qualify for the purchase of the marital residence;

• The financial risk the husband and/or wife undertake by encumbering themselves with the mortgage debt;
• The effect on the husband and/or wife’s credit to debt ratio as a result of being a party to the mortgage;
• The diligence and creativity often needed to secure a mortgage, such as: rapid pay-down of credit card debt; securing initial down payment cash from relatives and friends; convincing lenders to “bend the rules” a little
• The daily grind of working to pay the monthly mortgage bill (even if those monthly payments account for payoff of primarily mortgage interest, homeowner’s insurance and real estate taxes at the time of divorce).

THE “ONE SIZE FITS ALL” MODEL DOES NOT WORK WELL IN HYBRID REAL ESTATE SITUATIONS: Of course, with the ups and downs of the real estate and stock market, the proliferation of refinances, the pendulum swings in interest rates and the financial gymnastics many families go through to stay in their home, there is no formula (most reasonable people would agree) that could be fairly applied in all situations. There are, however, formulas that courts do apply and that some parties utilize during divorce mediations. Here are the most prevalent formulas for dividing the equity in the marital home in hybrid property situations:

THE BRANDENBURG DOCTRINE

Brandenburg v. Brandenburg, 617 S.W.2d 871 Ky.App. (1981), approved by the Virginia Courts in Hart v. Hart, 27 Va.App. 46 (1998)

The Brandenburg Doctrine

(1) Establishes the relationship between:

(a) the separate (non-marital) contributions to total (marital + non-marital) contributions; and

(b) the marital contributions to total contributions.

(2) Reduces the above relationships to percentages, which are then multiplied by the equity in the property, at the time of distribution, in order to establish the present value of the separate and marital portions of the equity.

(3) Only recognizes the contributions that account for the reduction in principal (which means that all contributions made toward the monthly mortgage payments for interest, homeowner’s insurance and real estate taxes do not count).

(4) Recognizes, as non-marital contributions, all financial contributions made toward the reduction in principal from both non-marital assets (money earned before the marriage, inheritance, and gifts to one of the spouses (not the marriage)) and to those payments made in reduction of principal which occur after the parties’ separation (not necessarily divorce).

(5) Recognizes money spent on improvements, from either marital or non-marital funds, but only in terms of how those expenditures increase the value of the real estate (as opposed to how much money was actually spent).

 

The Brandenburg Formula:

 Separate contribution
————————          x Total Equity    =    Separate interest
Total contribution

 

Marital contribution
————————       x Total Equity    =    Marital interest
Total contribution

 Brandenburg is Not “Gospel” in Virginia: Even though Brandenburg is an “approved method” by the Virginia courts, it is not the only method available to the judges when they are faced with a determination as to how to apportion hybrid property.

 Inherent Inequities in Brandenburg: Courts sometimes avoid using Brandenburg in order to prevent the harsh and inequitable division between marital and separate property that often results. For example, if a couple decides to buy a house, but only one of them has the cash necessary for the down payment (from money saved prior to the marriage), the results may be highly favorable to a spouse who made the down payment; but highly unfavorable to a spouse who contributed income to the payment of the monthly mortgage bills.

Specifically, once the husband and wife are married, all money earned during the marriage (by either one or the both of them) is marital money. Therefore, all income earned which is used to pay the monthly mortgage bill is classified as marital contributions. However, under Brandenburg, until those monthly mortgage payments begin making a dent in the principal, none of those payments made with marital funds are counted as anything more than “rent”.

THE KEELING CASE

Keeling v Keeling, 47 Va.App. 484, 624 S.E. 2d 687 (2006)

Judges Are Not Required to Apply Brandenburg: One of the most famous Virginia cases, which refutes the across-the-board use of the Brandenburg formula, is the Keeling case. The Appellate Court, in the Keeling case, chose to apply Brandenburg to calculate the equity in one of the parties’ pieces of real estate, but applied a different formula (now known as “The Keeling formula”) to calculate the marital equity in the couple’s other piece of real estate.

This was held to be proper and not an abuse of the court’s discretion because (as can never be emphasized too much) Virginia is an equitable distribution state and the court is permitted to divide and distribute marital property as it sees fair and just under the particular circumstances presented in each individual case – and that includes, to a certain extent, how property is classified (i.e. as marital or separate (non-marital) property). See, also, the case of Rinaldi v Rinaldi, 53 Va.App. 61, 669 S.E.2d 359 (2008)

Recognition of Financial Benefit to Marriage -- Credit Worthiness & Risk Taking: The Court of Appeals, in Keeling, felt that the application of Brandenburg would be harsh and inequitable. The Court reasoned that applying the Brandenburg formula would ignore the financial benefits made possible by the parties’ joint obligation to pay on the mortgage loan (i.e. both parties put their credit-worthiness on the line and assumed great liability and risk by assuming the mortgage loan which, the Court reasoned, should be worth something).

Recognition of Financial Benefit to Marriage by Paying Monthly Mortgage Bill: In addition, the parties’ monthly payments on the loan – whether those payments went toward principal, interest, insurance or taxes – were paid from marital income, and credit was reasonably due to the marital estate for those payments.

Further, the Court pointed out that the rising appreciation of real estate (at that time) made application of the Brandenburg formula highly unfavorable to the ratio of the marital versus separate equity shares by favoring the separate percentage share due to Brandenburg’s “principal only” rule.

Further, the Court of Appeals clarified that judicial use of a formula, such as Brandenburg, is permissible, but not mandatory in cases where there has been a commingling of separate and marital assets (such as when a down payment is made on the marital residence with one spouse’s separate assets).

Judges May Apply More Than One Formula In a Single Divorce Case, to Different Properties: Keeling also stands for the rule that Courts are permitted to apply Brandenburg (or another formula) to one property in a divorce, but another formula or method of classifying property (as marital or separate) for a different property in that same divorce case. In the Keeling case, the trial judge applied Brandenburg to one piece of real estate, but chose to use the following formula on another piece of real estate:

The Keeling Formula:

Separate contribution
————————       x Total Equity    =    Separate interest
Purchase Price

 

Total Equity
- Separate interest
Marital interest

The Keeling court decided to simply calculate the husband’s non-marital (separate) share of the home, at divorce, by establishing his separate interest in the equity of the residence at the same percentage as was his original non-marital contribution in relationship to the purchase price.

REASONABLE RATE OF RETURN

This formula has not appeared in any published Virginia opinions, but has appeared in at least one Circuit Court decision. See Thomas v. Wiese, CH2003-185175 (Fairfax Cir. Ct., McWeeney, J.).

To determine a party’s separate interest in hybrid property using the Reasonable Rate of Return “formula”, the parties apply a rate of return to the separate investment in an asset which is, otherwise, marital property (e.g., the down payment on the marital residence).

Applying the “Reasonable Rate of Return” method is considered by many to be the most flexible way to determine a party’s separate interest in an asset. This is because the rate to be used can be virtually any rate one can think up (and the parties can agree on). The idea behind this method is to give the party who made the down payment (or other valuable investment out of his or her separate assets) back their initial investment, plus some appreciation for the missed opportunity to invest those funds elsewhere. The rate of return can be based on almost anything, from the relatively low interest rate on 10, 20, or 30 year Treasury note, to the return on some measure of stock market performance, to a rate based on the appreciation of the asset itself. Of course, in a “down market”, depreciation is a factor for consideration, too, and might be a negative for the party who made the investment of separate assets into what is, otherwise, a marital property interest.

If the “Reasonable Rate of Return” formula seems right for your case, consider a consultation with a financial planner to help you and your spouse come up with a mutually agreed upon “rate of return” (a percentage) that can be applied to the separate (non-marital) investment in the real estate in question.

“IT WAS A GIFT”

 Though this “formula” does not appear in the law books, many clients in mediation (and, to a certain extent, litigation) choose to view their contributions of separate property (money), into the acquisition and/or maintenance and/or improvement of the marital residence (e.g., down payments, payment of monthly mortgage bill, payment toward improvements to the real estate, etc.), as “gifts” to the marriage.

There is nothing illegal or immoral about classifying separate contributions to the marital residence as “gifts”. Though there are often legal methods of avoiding this result, it is sometimes so offensive to the spouse who did not have the ready-cash to contribute money to the purchase of and/or maintenance and/or improvement of the marital residence – but who worked hard during the marriage in any number of ways to keep the family in a comfortable home (e.g. contributing income during the marriage for the payment of the monthly mortgage bill, housework and yard work, handy work, dealing with contractors, etc. – that the efforts made by the “moneyed spouse” to tease out his or her separate contributions taint the entire settlement process. This is very relevant in the settlement context.

“Ill will” and “bad faith” -- whether perceived or real -- are real when it comes to negotiation and reaching mutually agreeable settlement terms in a divorce mediation setting (or with your attorneys). Clients, I have found, know best what “pushes the buttons” of their spouse and know best where the tipping point is in terms of how the other spouse will perceive “greediness” and will react accordingly when it comes to negotiating the many other points of a divorce settlement.

Be smart. Be cool. Think before you go into a negotiation with a formula that is way outside of the normal course of thinking and financial behavior that was, otherwise, prevalent in your pre-divorce-tainted marriage. Though you might “win” by pushing a particular legal doctrine pertaining to hybrid property (part-marital, part-separate property), that “win” may backfire, later, if it violates your family’s general sense of fairness. For example, if you greatly offend your spouse, by classifying as your separate property that which was otherwise treated during your marriage as a “gift”, you may find that your spouse is much less willing to negotiate fairly in the other issue-areas left (such as spousal support, child support, retirement benefits & funds, bank accounts, credit card debt, tangible personal property, life insurance and custody). Be careful. Just because something is legal, does not make it “right”. Don’t push buttons unless that will get you a fair deal (all the way around) – and your kids the best chance possible for a soft landing -- in your divorce settlement.

[1] The commingling occurs when separate assets are put into the marital residence (in any number of ways). Usually, this commingling is in the form of a down payment on the marital residence, improvements to the marital residence, monthly mortgage payments out of a non-marital (separate) source of funds, and/or the use of a home purchased by one of the parties prior to the marriage as the marital home (but paying the mortgage, etc. with marital (e.g. salary) income).