When Separate Property Has Not Changed Form

 

Identifying certain types of separate property that exist at the end of a marriage is relatively straightforward.  Tangible assets that are unique in nature, such as a specific piece of real estate, for example, are easy to identify.  There can be little disagreement that a premarital piece of real estate, for example an undeveloped lot, that exists at the end of a marriage is the same property that existed at the beginning of the marriage.  Unfortunately, even simple examples, such as an undeveloped lot, require further analysis to determine if they still remain separate property at the end of  the marriage.  This analysis is performed by analyzing each transaction or event that affects the asset during the marriage.  These events, as introduced in Chapter One of the book, can by classified by transaction/event codes and are discussed later in this chapter.

 

When Separate Property Changes Form

 

When separate property changes form, the asset tracing task can become complicated.  When one unique tangible asset is exchanged for another unique tangible asset, the asset tracing is relatively straightforward.  But when the proceeds of assets sales are deposited into a bank account, for example, it becomes difficult to distinguish one dollar from another.  This is made more complicated when marital property is commingled with separate property in the bank account.  What then happens when a purchase is made out of the bank account that has become commingled?  What is the nature of the assets purchased from the commingled account?

 

The answers are theoretically simple but sometimes practically complex.  Under the Colorado Statutes 14-10-113 (2)(b) and (3), if the party claiming separate property cannot answer the above questions to the court's satisfaction, then the property will be presumed to be marital property.  How then does a party claiming separate property satisfy the court that it has produced an asset tracing accounting that overcomes the presumption that all property existing at the end of a marriage is marital? 

 

Attributes of a Successful Asset Tracing

 

In the author's opinion, a properly prepared asset tracing should be in accordance with the Colorado Statutes and case law, presented by using general accepted accounting methodologies.  The asset tracing should categorize all transactions that have occurred to a separate asset, from its creation until the end of the marriage, into separate and marital components.  The categorization of each transaction should be consistent with the Colorado Statutes, case law, and the facts and circumstances surrounding the asset.[1] [2] [3]

 

Asset Tracing Transactions and Events

 

As discussed in Chapter One of this book, most of the transactions and events that affect separate property can be categorized as follows:

 

1.   Transactions/events that create separate property

2.   Transactions/events that create a marital component to separate property

3.   Transactions/events that reduce the separate or marital component of property

 

The actual categorization of each transaction will require input from the attorney to the accountant as to the legal basis for categorization.  The following is a discussion of asset tracing principles that may affect the classification of transactions as separate or marital:

 

Transactions/Events that Create Separate Property

 

Property acquired prior to date of marriage

 

Property acquired prior to the marriage is generally considered separate property.[4]  Determining the specific items of separate property and their respective values at the date of the marriage is a factual issue.  The accountant is often called upon to document the existence of premarital property and to assist in the valuation process.  For example, the value of a closely held business at the date of marriage is often determined by a qualified accounting expert witness performing a business valuation.

 

Property acquired by gift, bequest, devise or descent

 

Property acquired subsequent to the marriage by gift, bequest, devise or descent (gifts) is generally considered separate property.[5]  The accountant is often called upon to verify gifts by tracing the gifts to gift tax returns or other documents.  If the purported gift is not traceable to supporting documents, then it usually becomes a legal issue to be resolved by the attorney in the case.

 

Property acquired in exchange for property acquired prior to the marriage or in exchange for property acquired by gift, bequest, devise, or descent

 

If property acquired in exchange for property acquired prior to the marriage or in exchange for property acquired by gift, bequest, devise, or descent is properly traced, it will be preserved as separate property.[6]  However, other transactions or events discussed elsewhere in this chapter may change the character of the property to a mixture of separate and marital property or to totally marital property.

 

Property acquired by a spouse after a decree of legal separation

 

Property acquired by a spouse after a decree of legal separation is generally considered separate property.[7]  However, if the property is acquired with marital property, asset tracing may be required to establish the separate and marital components of the property.

 

Property excluded by valid agreement of the parties

 

Property excluded by valid agreement of the parties is generally considered separate property.[8]  This refers to pre and post marital agreements between the parties.  A pre or post marital agreement is essentially a financial contract just like any other partnership agreement. 

 

Premarital agreements should  make property settlements simpler and more predictable.  Unfortunately, a poorly drafted premarital agreement can often complicate a property settlement and add a greater degree of uncertainty than would otherwise exist without an agreement.  Without a premarital agreement, the accountant's task is to assist his or her client in identifying available assets and to classify them into marital and separate categories.  With a premarital agreement, the accountant's job becomes one of preparing an accounting of what each party is due under the agreement. 

 

Without an agreement, marital assets are identified and the court determines the division.  With a premarital contract, it is often necessary to prepare a complete accounting of every transaction during the marriage.  This is analogous to the  accounting  done for a business, which would include the preparation of cash receipts and disbursements journals, general ledgers, balance sheets and income statements.  Preparing an accounting after many years of marriage is time-consuming and extremely expensive, although it can be done.  It is analogous to putting a multi-thousand piece jigsaw puzzle together with many damaged or missing pieces.

 

Once the accounting for the agreement is completed, the accountant and attorney must consider how it relates to the other provisions of Colorado Statute Section 14-10-113.

 

Transmutation of property

 

As it relates to asset tracing, transmutation refers to a change in the character of property from separate to marital or vice versa.  Whether or not a transmutation of property has occurred is a legal conclusion and should be decided by the attorney.  The most common types of transmutation that might occur are as follows:

 

    Transmutation by agreement.  An example would be a valid pre or post marital agreement between the parties.[9]

 

    Transmutation by title.  An example would be when separate property is retitled to a form of joint title.[10]

 

    Transmutation by interspousal gift.  An example would be when one spouse makes a gift to the other spouse.[11]

 

    Transmutation by use.  This refers to the concept that separate property used by both spouses may become marital property.[12]

 

 

 

 

Transactions/Events that Create a Marital Component to Separate Property

 

Appreciation in value of separate property during the marriage

 

Appreciation in the value of separate property during a marriage is considered marital property.[13]  In order to determine appreciation in separate property, it is necessary to value separate property both at the time it is created and at the end of the marriage.  The difference in these two values being the marital component of otherwise separate property.  If separate property has not changed form during the marriage, it should be sufficient to compute the appreciation at the end of the marriage.  If, however, the separate property has changed form during the marriage, it may be necessary to compute appreciation of separate property each time it changes form.  For example, if a stock brokerage account is separate property at the time of marriage, over time it will develop a marital component.[14]  Each time a stock is sold, the proceeds must be categorized as separate and marital property.  The portion of the proceeds that represents the value at the date of marriage would be separate and the appreciation since the date of marriage would be marital property.

 

Income during the marriage

 

Income during the marriage is generally considered to be marital property.[15] [16] [17]  Therefore, any income earned during the marriage that is used to acquire, maintain, and carry an asset during the marriage could create a marital component to separate property.  For example, in the above stock brokerage account, dividend and interest income earned during the marriage would create a marital component to the account.  If a pre-marital stock is sold and a replacement stock purchased, the resulting stock could contain marital components because of dividend income, interest income, and appreciation on the sale of the pre-marital stock used to purchase a portion of the replacement stock.

 

Use of marital property to carry, maintain or improve separate property

 

Use of marital property to carry, maintain or improve separate property could create a marital component to separate property.[18]  For example, assume pre-marital separate property worth $100,000 is subject to a $50,000 mortgage at the date of marriage.  During the marriage, marital property is used to reduce the mortgage to $20,000.  Also assume the property did not appreciate in value during the marriage.  Presumably, the increase in equity resulting from the mortgage reduction would create a marital component of $30,000 in the property.[19]

 

Transactions/Events That Reduce the Separate or Marital Component of Property

 

Distributions/withdrawals

 

Distributions and withdrawals from a separate asset reduce the separate asset.[20]  While the withdrawal from the separate asset may create another separate asset, the specific asset from which the withdrawal occurs will be reduced by the amount of the withdrawal. 

 

When the withdrawal is made from an asset that contains both marital and separate property components, the withdrawal must by categorized as marital, separate, or a combination of both.  This process can become quite cumbersome in an asset tracing accounting, with each withdrawal requiring an analysis of its nature.  The following methods of categorization may be appropriate. 

 

     If the expenditure is to maintain separate property or to be exchanged for other separate property, it can be categorized as reducing the separate property component of the account. Once the separate property component of the account is reduced to zero, the separate property ceases to exist and the asset tracing for that particular asset is complete.

 

A question often arises when a spouse intends to exchange separate property in a commingled fungible type asset account (that has been properly traced to comply with Colorado Statute 14-10-113) for other replacement separate property.  What methodology should be used to determine the marital and separate components of the replacement property?  Assume for example that a cash account contains $300,000, of which $100,000 is the wife's separate property and $200,000 is marital property.  Also assume that the wife writes a check on the account to purchase a vacation home for $100,000 and it is the wife's intent that she exchange her separate property contained in the checking account to purchase the home.  What is the compositional mix of separate and marital property in the replacement vacation home?  Two possible answers are as follows:

 

Pro-rata Method

 

Under the pro-rata method, the vacation home would consist of $33,333 of separate property and $66,667 of marital property.  Under this method the distribution or withdrawal from an asset containing separate and marital property would always be proportional to the relationship of separate to marital property contained in the asset account at the time of the withdrawal to purchase the exchange property.

 

Positive attributes of method

 

This is a mechanical test and is easy to apply.

 

Negative attributes of method

 

This method precludes, or at least severely limits a spouse's ability to exchange separate property.  In the above example, why should a spouse not be allowed to use $100,000 of separate property in the cash account to acquire $100,000 of replacement separate property?  This method, in effect, limits the spouse's freedom to exchange separate property.

 

Intent or Facts and Circumstances Method

 

Under the intent method, the vacation home would consist of $100,000 of separate property and no marital property.  Under this method the distribution or withdrawal from an asset containing separate and marital property would be determined by the contemporaneous intent of the party withdrawing the funds.  To the extent that enough separate property exists in the asset to purchase exchange separate property, the resulting exchanged property would be classified as separate property.

 

Positive attributes of method

 

This method allows a spouse the opportunity to exchange separate property without being forced to include a marital component to the exchanged property.  Since it is not a mechanical test, it allows the court the opportunity to examine the spouse's intent along with the surrounding facts and circumstances.

 

Negative attributes of method

 

This is a facts and circumstances test and is more difficult to apply than the pro-rata method.

 

Colorado Statute 14-10-113 does not explicitly endorse either method.  The author is not aware of any Colorado case law that explicitly endorses either method.  Therefore, until there is controlling case law, it is presumed that the court will make its decision based on each individual judge's impression of the legislative intent of Section 14-10-113.

 

     If the expenditure is related to marital property, it can be categorized as reducing the marital component of the account until it is exhausted.  It would then reduce separate property.

 

     Under the "Family Expense Doctrine," if a withdrawal is used to pay a family living expense, the withdrawal is deemed from marital property, to the extent of marital property in the account[21].  Any expenditure in excess of the marital property in the account would reduce separate property.

 

     Under the "Marital-Property-Out-First" rule, any withdrawal from the account is deemed marital to the extent there are marital funds in the account.  There is a difference between this approach and the Family Expense Doctrine.  The Family Expense Doctrine requires proof that the withdrawal was used to pay for family living expenses while the Marital-Property-Out-First doctrine assumes, whenever there is a withdrawal during the marriage, marital property is reduced first.[22]

 

The accountant should seek guidance from the attorney on which methodologies are accepted by the local courts and on how to categorize withdrawals accordingly.

 

Depreciation in value

 

Depreciation or reduction in value reduces separate property.[23]  Reductions in value should apply to each item of identifiable separate property and thus not be netted against appreciation of another separate asset.[24]  When the asset contains elements of both separate and marital property, the accountant must make a determination to apply the depreciation in value to the separate and or marital components of the asset.  If the marital component of the asset was the result of temporary appreciation, then logically, the depreciation should reduce the marital component to the extent of any appreciation.  Any depreciation in excess of marital appreciation would then reduce separate property.  If  the marital component of the property was the result of marital funds contributed to the asset, a logical approach would be to reduce the marital and separate components of the assets on a pro-rata basis.  As with all classifications, the accountant should consult with the attorney when questions arise.

 

 

Commingling

 

Black's Law Dictionary defines commingle as "to put together in one mass."[25]  As it relates to asset tracing, commingling refers to the mixing of separate and marital property in the same asset or account.  When separate and marital property are mixed during a marriage, there is a presumption that the entire asset or account is marital.  The presumption is overcome by a showing that the property was acquired by the method listed in subsection (2) of 14-10-113 of the Colorado Statutes.  In other words, the presumption that property that exists at the end of a marriage is marital, is overcome by uncommingling the asset.  This is accomplished by the process of asset tracing.[26] [27] [28]  Asset tracing, as discussed in Chapter One, is an accounting process that traces an asset from its separate property beginnings through all of its mutations and demonstrates that the resulting asset in existence at the date of divorce is either separate, marital, or a combination of the two.

 

Transmutation of property

 

See previous discussion in this chapter.

 

Other Asset Tracing Issues

 

Fungability

 

The concept of fungability is closely related to the issue of commingling of marital and separate property.  Black's Law Dictionary defines Fungible Things as "Moveable goods which may be estimated and replaced according to weight, measure, and number.  Those things one specimen of which is as good as another, as is the case with half-crowns, or pounds of rice of the same quality."[29]  The most common fungible asset encountered in asset tracing is money.  It is virtually impossible to distinguish one dollar from another in a bank account or a money market account.  Additionally, in our modern society, assets are rarely traded or exchanged directly for other assets.  They are almost always sold for money that is immediately deposited and commingled with other funds in a cash or brokerage money market account. 

 

Once a previously separate asset is sold, converted to cash, and commingled into a fungible type account, it becomes necessary to perform a detailed asset tracing of that account.  This is necessary because any subsequent asset purchase in the account or withdrawal from the account cannot be properly classified into separate and marital components without first knowing the amount of separate and marital property in the account immediately before the purchase or withdrawal.  In other words, the components of a fungible type asset account must be accounted for on a cumulative basis.

 

Entity vs. Aggregate Issues

 

For asset tracing purposes, should an asset account be viewed as an asset entity separate from its underlying components or as an aggregate asset viewed as a collection of assets within the account?  For example, under a strict entity approach, in a stock brokerage account containing five stocks, and a money market account, the brokerage account itself would be considered the asset for tracing purposes.  Under the aggregate approach, the underlying stocks and cash account would individually be considered the assets for tracing purposes.

 

Cash accounts, as discussed in the fungability section of this chapter, by their very nature must be traced using an entity approach.  Money market accounts are similar in nature to cash accounts, in that they are fungible and generally do not have gain and loss transactions apart from dividend income credited to the account.

 

Brokerage accounts are partly fungible and partly not fungible.  Most brokerage accounts hold specifically identifiable assets in addition to fungible cash or money market type assets.  Therefore, in the author's opinion, a proper brokerage account tracing should use an aggregate tracing for all specifically identifiable assets (securities) held in the account and an entity tracing approach for all fungible cash or money market type assets held in the account.

 

When specifically identifiable assets are sold, deposited into a money market account, and new specifically identifiable assets are purchased from the money market account, the tracing process must by necessity combine both aggregate and entity tracing methods to properly trace all assets in a brokerage type account.

 

The use of a strict entity tracing method applied to a brokerage account can result in the overstatement of separate property in a brokerage account.  This can be demonstrated by the following asset tracing spreadsheets.  For three periods of time, separate spreadsheets have been prepared for a brokerage account on the entity tracing method and on the aggregate/entity tracing method.[30] 

 

At the end of the first period, separate property is overstated by $50,000 on the entity tracing spreadsheet.  This is the result of netting $50,000 of unrealized losses on Stock A against $50,000 of unrealized gains on Stock B.[31] [32]

 

At the end of the second period, separate property is overstated by $25,000 under the entity tracing method.  This is the result of netting $25,000 of cumulative unrealized losses on Stock A against $60,000 of cumulative unrealized gains on Stock B.  In addition, on the entity tracing spreadsheet, it is now impossible to trace the separate and marital components of each individual asset contained in the brokerage account.  The separate component of Stocks A and B could be reconstructed by  comparing their value at the beginning of period one to their respective values at the end of period two.[33]  The separate property component of Stock D, a replacement stock acquired subsequent to marriage, cannot be determined without a tracing of the money market account from which it was purchased.  Because it was not specifically traced under the entity tracing, the separate property component of the money market account cannot be determined.  Without an aggregate/entity tracing, the separate property components of both Stock D and the money market account would now be lost.

 

At the end of the third period, separate property in the brokerage account is overstated by $38,842.  This is the result of netting $25,000 of cumulative unrealized losses on Stock A and $9,017 of cumulative net losses on Stock D against cumulative unrealized gains of $90,000 on Stock B, and the result of allocating $4,825 too little separate property to the distribution of $45,000 from the money market account to purchase a limited partnership interest.  The separate component of Stocks A and B could be reconstructed by comparing their value at the beginning of period one to their respective values at the end of period three.[34]  Without an aggregate/entity tracing, the separate property components of both Stock D and the money market account would now be lost.  In addition, the separate property component of the limited partnership interest purchased by a withdrawal from the money market account would be commingled with the marital component and thus lose its separate property component.[35]

 

 

 

See Spreadsheets on Following 6 Pages

 

Not Available Online

 

Click Here To Order Book

 

 

Different Asset Tracing Standards for the Parties

 

In addition to preparing an asset tracing accounting for his or her client, an accountant may be called upon to give expert testimony as to whether, in the expert's opinion, his or her client's spouse has uncommingled an asset.  Is there a difference between the asset tracing standards imposed on the party claiming separate property and the party attempting to refute a claim of separate property?

 

An adequate asset tracing of an asset, as it relates to the party claiming separate property, would involve categorizing all transactions that have occurred to the asset, from its creation until the end of the marriage, into separate and marital components.  The categorization of each transaction must be consistent with the Colorado Statutes, case law, and the facts and circumstances surrounding the asset. 

 

If the party claiming separate property or his or her accounting expert does not produce an asset accounting as described above, what would constitute an adequate asset accounting by the opposing party or his or her accounting expert?  Would the standards be different?  The answer to the latter question, in the author's opinion, is yes. 

 

According to the Colorado Statutes 14-10-113 subsection (3), there is a presumption that all property acquired by either spouse subsequent to the marriage is marital property.  During a marriage, an asset account, a stock brokerage account for example, will usually have many transactions.  These transactions can include income earned, sales of appreciated securities, contributions of additional property, distributions from the account, and securities purchased subsequent to the marriage.  If a party is unable to identify specific items of property that have existed in the same form during the entire marriage, the separate property in the brokerage account will become commingled with marital property.  It is therefore the burden of the party claiming separate property to uncommingle the brokerage account by producing an asset tracing accounting to preserve the separate property.  In the absence of such an asset tracing accounting, the opposing accounting expert should be able to rely on the presumption that untraced property in a commingled account is marital property.[36] [37]

 

The opposing party's accounting expert should, in theory, be required to account for any separate property documented by the claiming party and presume that the remaining property in a commingled account is marital.

 

Need to Trace all Transactions in an Account

 

Is it necessary to trace, in detail, all transactions in an asset account in order to perform a proper asset tracing accounting?  Using a stock brokerage account as an example, the answer in the author's opinion is a qualified no.  Certain transaction types always result in marital property.  Generally all income during the marriage and appreciation of separate property during a marriage results in marital property.  Using a shortcut approach to tracing, if the accountant uses accurate annual income and appreciation summaries, provided by the brokerage company, and classifies all income and appreciation occurring during the period as marital property and all depreciation occurring to separate property as reducing separate property, it is theoretically possible to correctly state the marital and separate components of the account at the end of a marriage.

 

Contributions to an account and disbursement from the account, however, must be accounted for on a transaction by transaction basis.  This is due to the fact that contributions and disbursements do not always result in the increase or reduction of one property type, but can be from separate, marital, or a combination of both.

 

In the author's opinion, the use of shortcut asset tracing methods should be avoided when possible and are an inferior method of asset tracing when compared to a detailed aggregate/entity asset tracing.

 

Strategic planning

 

Because asset tracing is a time consuming process, not engaging an accounting expert early on in a case can be a strategic mistake.  Take the following example:

 

Two attorneys, we will call them Mr. Easy and Mr. Thoughtful, are involved in a divorce case.  Mr. Easy's client is claiming a material amount of separate property.  His client thinks he can present his separate property claims himself and does not want to spend much money on the divorce process.  Mr. Thoughtful, upon hearing of the separate property claims of Mr. Easy's client, immediately hires an expert accounting witness to evaluate Mr. Easy's client's separate property claims.

 

On the day of Mr. Easy's client's deposition, Mr. Easy is surprised to see Mr. Thoughtful show up at the deposition with an accounting expert witness.  During the course of the deposition, it becomes apparent to Mr. Easy that his client is being asked detailed asset tracing questions, and worse, it becomes apparent that his client's responses to the questions do not help his separate property claims.

 

Five days later, and sixty days before the permanent orders hearing, Mr. Easy's secretary deposits Mr. Thoughtful's expert's detailed asset tracing report on Mr. Easy's desk.  Mr. Easy immediately reads the report and is quite alarmed to find the expert's report refutes the vast majority of Mr. Easy's client's separate property claims.  Mr. Easy is also mindful that, under the Colorado Rules of Civil Procedure rule 26.2, his asset tracing expert's report, if he had been thoughtful enough to engage one, would be due today.

 

Mr. Easy, now in a semi-panic, calls to hire his favorite accounting expert.  Mr. Easy is concerned that under the Colorado Rules of Civil Procedure rule 26.2 his expert witness has only twenty days to produce a report, and worse yet, the report will be limited to rebutting the subject matter of the opposing expert.  Mr. Easy reaches his expert's secretary who informs Mr. Easy that the accountant is on vacation and will return in ten days.

 

Ten days later, the accounting expert is sitting in Mr. Easy's conference room sorting through a mass of documents in an attempt to analyze the asset tracing issues in Mr. Thoughtful's expert's report.

 

Three days later, the accounting expert informs Mr. Easy that he needs several key documents from the opposing party in order to refute the opposing expert's report.  Mr. Easy immediately phones Mr. Thoughtful's office and requests the documents.

 

Four days later, Mr. Thoughtful returns Mr. Easy's phone call and informs him that Mr. Thoughtful's client is on an extended vacation and will not return until two days before the permanent orders hearing.  Mr. Thoughtful explains that only his client knows the location of the information and in addition, expresses little sympathy for Mr. Easy's eleventh hour request.

 

Twenty days from the delivery by Mr. Thoughtful of his expert's asset tracing report on the due date of Mr. Easy's expert's rebuttal report, Mr. Easy's expert informs Mr. Easy that without the additional information it is impossible to refute Mr. Thoughtful's expert's report.

 

Two weeks later, the case settles based on Mr. Thoughtful's expert's report.

 

Discovery

 

An adequate asset tracing cannot be prepared without documentation.  Documentation, by way of an analogy, is the raw material of asset tracing.  Discovery is the formal legal process of obtaining the raw material to prepare an asset tracing.  Discovery in Colorado marital dissolutions is governed by the "General Rules of Civil Proceedure, Rule 26.2 General Provisions Governing Discovery; Duty of Disclosure (Domestic Relations)."[38]  The discovery schedule is determined by "The Colorado Rules of Civil Proceedure Rule 16.2 Case Management (Domestic Relations)."[39]  The discovery process usually consists of the follow elements:

 

     Each party requests documents from the opposing party.[40]

 

     Each party may issue interrogatories (questions) to be answered by the opposing party.[41]

 

     Each party may submit requests for admissions to the opposing party.

 

     Each party may hold depositions of opposing witnesses.

 

Since discovery is a formal legal process, and the rules and timing of the process are defined under the Colorado Rules of Civil Procedure, it is imperative that the accountant and attorney anticipate and coordinate their efforts to obtain information through the discovery process.  Special thought should be given to information needed for the asset tracing that will not be provided by the opposing party in Pattern Interrogatories, Pattern Production of Documents, and mandatory disclosures.  As was demonstrated by the example in the Strategic Planning section, missed opportunities to gather documentation relevant to an asset tracing may preclude or seriously impede an accounting expert from preparing an asset tracing or refuting the asset tracing of an opposing accounting expert.

 

It is not uncommon in most divorce cases that one spouse will have more access to documentation than another.  If the accounting expert represents the spouse having access to the majority of information needed to complete an asset tracing, the discovery process is obviously less important to the asset tracing task.  If, however, the accounting expert represents the spouse without access to information, the discovery process is crucial to the engagement.  Therefore, one of the first tasks of the attorney and accountant in an asset tracing engagement is to ascertain who controls the data.

 

The type and duration of documentation needed will depend on the assets being traced.  If the asset to be traced is a fungible type asset, such as a bank account or stock brokerage account, detailed monthly information from the date of marriage or gift until the end of the marriage may be needed.  If the asset to be traced is a tangible asset that has not changed form, less information will be needed.  The following is a list of possible source documents to be obtained:[42]

 

     All statements from bank, savings and loan, individual retirement, and brokerage accounts as well as all canceled checks, deposit slips, check registers, and broker advices

     A listing by each spouse of property acquired by gift or inheritance

     Gifts tax and estate tax returns supporting claims of separate property

     A listing with fair market values by spouse of separate property at the date of the marriage

     Pre-marital and post-marital agreements

     Legal documents evidencing ownership of assets including deeds

     Notes and collateral documents

     Individual and business income tax returns

     Personal financial statements

 

 

Paying attention to the quality of documentation used in an asset tracing is essential.  The accountant should be mindful that every entry in the asset tracing accounting is subject to scrutiny at his or her deposition and at trial.  Therefore, a special effort should be made to obtain the most reliable and convincing information.  A gift tax return for example, filed contemporaneously and  under penalty of perjury would usually be given more credibility than a deposition statement that an undocumented gift had occurred. 

 

When the court is presented with conflicting asset tracing results by opposing expert witnesses, it must decide which is more credible.  The quality of documentation along with the soundness of the methodologies used will be taken into consideration by the court in determining which expert will prevail.  The expert witness should be mindful that when deciding which expert witness is more credible, the court will favor the witness presenting the greater weight or preponderance of evidence.[43]  The concept of preponderance deals with deciding which evidence is more credible and convincing and relates to its quality as well as quantity.

 

In a perfect world, expert witnesses would not encounter conflicting documentation.  As a practical matter, it is often encountered.  Resolving issues of conflicting documentation necessitates the use of professional judgment by the expert witness.  If, for example, the accountant has a contemporaneously written document signed under penalty of perjury (i.e. a tax return) that is in direct conflict with the deposition testimony of a spouse, the accountant must make a decision about which information to rely on.  In these situations, in the author's opinion, the accountant should discuss the issue with the attorney.  In the final analysis, the accountant must rely on his or her objective professional judgment and be prepared to explain his or her position to the court.  The Certified Public Accountant (C.P.A.) should be mindful that under Rule 102 of the AICPA's Code of Professional Conduct, "a member shall maintain objectivity and integrity, shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others."

 

For an expert accounting witness, there is a fine line between adhering to the professional obligation not to subordinate his or her professional judgment to others and deferring to attorneys for legal conclusions.  Since non-attorney expert accounting witnesses are generally not qualified to render legal opinions and conclusions, they must by necessity defer to attorneys for guidance on classifying transactions that involve legal issues and conclusions.  Unfortunately, it is not always clear to the accountant when he or she should consult with the attorney.  As a general rule, the author suggests that the accountant consult the attorney whenever he or she has a question.  With experience, the accountant will develop a feel for when it is appropriate to consult with the attorney.  When questioned at deposition or at trial, the accountant should disclose to the court whenever he or she has deferred to any legal conclusion supplied by the attorney.

 

Professional standards of C.P.A. expert witnesses

 

Certified Public Accountants who perform litigation services are bound by professional standards issued by the American Institute of Certified Public Accountants (AICPA).  These services are defined as consulting services.  C.P.A.'s who perform consulting services must adhere to the AICPA's Statement on Standards for Consulting Services and to the general standards of  the accounting profession contained in the AICPA Code of Professional Conduct.  Any C.P.A. offering asset tracing services should be familiar with the content of the above documents as well as the following AICPA publications:

 

     Application of AICPA Professional Standards in the Performance of Litigation Services - Consulting Services Special Report 93 - 1

     Conflicts of Interest in Litigation Services Engagements Consulting Services Special Report 93 - 2

     Providing Litigation Services - Consulting Services Practice Aid 93 -4

     Communicating in Litigation Services: Reports - Consulting Services Practice Aid 96 -3

 

Report Writing Standards

 

Non authoritative guidance for report writing by C.P.A. expert witnesses can be found in the AICPA's Communicating in Litigation Services: Reports - Consulting Services Practice Aid 96 -3.  The follow is an example of an expert's report on an engagement that includes material asset tracing:[44]

 

 

Expert's Preliminary Report

 

 

I.  Introduction and Assignment

 

I was retained by Sally Smith and asked to do the following:

 

     Prepare a schedule of assets, liabilities, and net worth to be used for property settlement purposes.  The schedule reflects the following:

 

1.  A listing of the couple's marital and separate property, including fair market     values and ownership

 

2.  The assets and liabilities that are subject to distribution (marital property)

 

3.  For illustrative purposes, the portion of each marital asset and liability which a particular spouse would be entitled to under an equal distribution

 

4.  A proposed distribution of marital assets and liabilities between the spouses assuming an equal distribution

 

     Prepare an accounting of Sally Smith's separate property

 

     Review data and information submitted by Dick Smith related to his claims of separate property and render an opinion as to the validity of his claims

 

II.  Expert Opinions

 

It is my expert opinion that the amounts reflected as separate and marital property throughout this report are consistent with the Uniform Dissolution of Marriage Act section 14-10-113.  All items reflected as separate property have been traced and accounted for and are not marital property.  In my expert opinion, all items claimed by Dick Smith as separate property, and not classified in my report as separate property, have not been traced and accounted for in a manner that overcomes the presumption that they are marital property.

 

III.  Work Performed

 

I reviewed the information listed below under "Information Considered."  This information included both Petitioner's and Respondent's disclosures, financial affidavits, claims of separate property, gift tax returns of June Smith, inheritance documents, Dick's deposition testimony and other supporting documentation.  I then prepared an accounting related to separate property claims.  This accounting is contained in Tabs G, H, I, J, K, L, M, N, O, P, Q and S of my report.

 

Based on the above information, I prepared a Schedule of Assets, Liabilities, and Net Worth as described in the "Introduction and Assignment" section of my report.

 

IV.  Information Considered

 

In preparing this report and forming the opinions expressed, I have considered the following:

 

     All information contained in this report

     All information contained in "Smith Data I, II, and III" binders

     All information contained in the expandable folder from John Sharp, Esq., including tax returns and miscellaneous financial data

     Deposition attendance and transcript of Dick Smith

     Information contained in my files

     Conversations with Sally Smith

 

I have also considered my knowledge, training and professional experience as a Certified Public Accountant.

 

V.  Bases for Opinions

 

My expert opinions on classification of various properties in my report as separate or marital are based on my understanding of section 14-10-113 of the Colorado Uniform Dissolution of Marriage Act.  They are also based on my 23 years of experience as a Certified Public Accountant and in knowing what constitutes an adequate accounting to trace separate property.

 

VI.  Experts Qualifications

 

I am the sole proprietor of Lily Parsons & Associates, an accounting firm specializing in litigation and dispute resolution services engagements.  I am a Certified Public Accountant, licensed to practice in Colorado and North Carolina.  I am also a Certified Valuation Analyst.  I presently devote approximately 50% of my time and 30% of my firm's total time in the litigation and dispute resolution area.  I have previously testified as an expert witness in marital dissolution cases.  I have previously served as court appointed special master in cases involving complex financial issues and amounts due under pre-marital agreements.  I have previously served as court appointed receiver in cases involving a closely held business and real estate.  A copy of my current resume including my current and past employment, professional affiliations, and a schedule of litigation, mediation and business valuation engagements during the past four years is provided in Tab V.

 

My fees are billed based on the amount of time spent at my billing rate of $185 per hour.  Other firm personnel working on the project include Paul Bryan at $90 per hour and Doreen Dunn at $59 per hour.  My compensation is not contingent on the outcome of this litigation.

 

Additional work contemplated, but not yet completed, is the analysis of additional documents requested from Dick Smith at his deposition but not yet received, review of June Smith's deposition transcript when available, June Smith's 1996 gift tax returns, Dick Smith's expert's opinions, preparation of possible demonstrative exhibits, preparation to testify, and attendance at depositions and trial.  Because of the scope of the additional work listed above, this report is issued as a "Preliminary Report".  Any modifications to this report due to additional data or further analysis will be reflected in the issuance of a "Final Report".

 

Sincerely,

 

 

Lily Parsons , C.P.A.

 

May 1, 1997

 

Click Here To Order Book

 

Click Here to Discuss Asset Tracing With Mr. Melton

 

 



[1]In In Re Marriage of Stedman, 632 P.2d 1048 (Colo.App. 1981) the husband brought approximately $40,000 in savings into the marriage.  Upon dissolution, he claimed that the $40,000 was his separate property.  The court stated that since the husband could not trace any property acquired during the marriage back to the $40,000, there was nothing he could claim as separate property.  Simply being able to prove that a certain amount of separate property was brought into the marriage is insufficient to overcome the presumption of marital property.  See McCarren and Bean, Standards for Tracing Marital Property Back to Non-Marital Property, The Colorado Lawyer p853 (1988)

[2]In In Re Marriage of Killgore, 532 P.2d 386 (Colo.App. 1974), the husband brought approximately $40,000 in stocks into the marriage.  He also received annual gifts from his grandmother of $3,000.  This property was commingled with other property and ultimately used, at least in part, for the purchase of a home and an automobile.  The trial court determined that because of the commingling, property which otherwise would have been separate had become marital.  The Court of Appeals affirmed this determination, recognizing that the funds had gone through numerous transactions between accounts which both parties had maintained separately and together.  See McCarren and Bean, Standards for Tracing Marital Property Back to Non-Marital Property, The Colorado Lawyer p853 (1988)

[3]When one spouse causes title to be placed jointly with the other spouse, a gift is presumed, and the burden to show otherwise is upon the donor.  Parties' explanation that title to their home was placed in joint tenancy so as to avoid inheritance taxes does not overcome the presumption that a gift occurred; it merely expresses a reason why the gift was made.  In re Moncrief v. Moncrief, 36 Colo. App. 140, 535 P.2d 1137 (1975)

[4]Colorado Revised Statutes 14-10-113 (2).

[5]Colorado Revised Statutes 14-10-113 (2) (a).

[6]Colorado Revised Statutes 14-10-113 (2) (b).

[7]Colorado Revised Statutes 14-10-113 (2) (c)

[8]Colorado Revised Statutes 14-10-113 (2) (d).

[9]Colorado Revised Statutes 14-10-113 (2) (a) and (d).

[10]When one spouse causes title to be placed jointly with the other spouse, a gift is presumed, and the burden to show otherwise is upon the donor.  Parties' explanation that title to their home was placed in joint tenancy so as to avoid inheritance taxes does not overcome the presumption that a gift occurred; it merely expresses a reason why the gift was made.  In re Moncrief v. Moncrief, 36 Colo. App. 140, 535P. 2d 1137 (1975).

[11]Colorado Revised Statutes 14-10-113 (2)(a).

[12]The author is not aware of any Colorado case law supporting transmutation by use.

[13]Colorado Revised Statutes 14-10-113 (4).

[14]Unless excluded by a valid agreement of the parties under Colorado Revised Statutes 14-10-113 (2) (d).

[15]The earnings of both spouses are marital property.  Thus, savings from the earnings of one or both spouses is marital property; that is, property acquired during the marriage to which none of the exclusions is applicable.  All manner of compensation earned during the marriage is marital, regardless of when it is paid.  See Sampson, "Marital" or "Separate" Property: An Overview for Practitioners, The Colorado Lawyer p571-575 (March 1995)

[16]Rents and other income received during the marriage from separate property presumably are marital property because they were acquired during the marriage.  However, the Colorado Supreme Court expressly left this issue undetermined in In re Marriage of Jones, 812 P.2d. 1152 (Colo. 1991).  Thus, if the income represents an investment return on a depreciating asset, an argument may be available that such property is "in exchange for" separate property and therefore separate property.  However, case law suggests that the party claiming separate property would have the heavy burden of tracing all separate premarital property to sustain such an argument.  See Sampson, "Marital" or "Separate" Property: An Overview for Practitioners, The Colorado Lawyer p571-575 (March 1995)

[17]In In Re the Marriage of Jones, 791 P. 2d 1173 (Colo.App. 1989, cert. granted 812 P.2d 1152 (Colo. 1991), aff'd in part, rev'd in part, The Supreme Court stated that "the income here was from a trust that was neither the wife's marital property nor separate property....Hence the income received by the wife from the trust is more properly a "gift" under subsection 10-10-113 (2)(a) and thus not divisible."  See Zuber, Classifying Income, Rents and Profits from Separate Property, The Colorado Lawyer, p1303-1307 (June 1994) for a detailed discussion.

[18]While Colorado Revised Statute 14-10-113 does not explicitly state that the use of marital property to carry, maintain or improve separate property would create a marital component to separate property, deductive reasoning would suggest that the use of marital property for any of these purposes would create a marital component to separate property.

[19]See Sampson, "Marital" or "Separate" Property: An Overview for Practitioners, The Colorado Lawyer p572 (March 1995) for a parallel discussion of marital property created through payment of a separate mortgage with marital funds.

[20]While Colorado Revised Statute 14-10-113 does not explicitly state that distributions and withdrawals from a separate asset reduce the separate asset, deductive reasoning would suggest that they do in fact reduce the particular property.

[21]Tracing, Commingling, and Transmutation, by J. Thomas Oldham, Family Law Quarterly, Volume XXIII, Number 2, Summer 1989

[22]Tracing, Commingling, and Transmutation, by J. Thomas Oldham, Family Law Quarterly, Volume XXIII, Number 2, Summer 1989

[23]While Colorado Revised Statute 14-10-113 does not explicitly state that depreciation in the value of a separate asset reduces the separate asset, deductive reasoning would suggest that it does in fact reduce the value of separate or marital property to be set aside by the court.

[24]In In re the Marriage Burford, No. 93CA1798 and No. 93CA2070 (Colo. App. 1997) the Court of Appeals stated that "Section 14-10-113, C.R.S. 1997, sets forth the required method for evaluating the marital estate.  That statute provides that "marital property" does not include property acquired by either of the spouses prior to the marriage.  However, Section 14-10-113(4), C.R.S. 1997, provides that: An asset of a spouse acquired prior to the marriage shall be considered as marital property, for purposes of this article only, to the extent that its present value exceeds its value at the time of the marriage. (emphasis supplied) Hence, the amount by which the present value of any particular asset exceeds its value at the time of the marriage constitutes a marital asset.  In contrast, Section 14-10-113(1)(d), C.R.S. 1997, provides that, in determining a "just" distribution of the martial estate, the court must consider, among other things: Any increases or decreases in the value of the separate property of the spouse during the marriage or the depletion of the separate property for marital purposes. (emphasis supplied) On their faces, these statutory directives distinguish between an increase in the value of "an asset," which is itself a part of the marital estate, and an increase or decrease in the overall value of a spouse's "separate property," which is not a part of the marital estate, but which is one of the economic circumstances to be considered in determining an equitable division of that estate.  And, that distinction in language implies a distinction in meaning.  A spouse's "separate property" consists of all of the separate assets owned.  "An asset," however, is only a single item, which may comprise only a part of the spouse's "separate property."  Hence, in carrying out the division of the marital estate in accordance with Section 14-10-113, the dissolution court should first add to the marital estate the amount of increase during the course of the marriage, if any, in each asset that was owned by each party before the marriage.  For this purpose, any asset suffering a decrease in value should be disregarded.  Section 14-10-113(4), requires that the increased value of each asset be added to the marital estate; the net overall increase or decrease in value of all of the spouse's separate property is not to be considered for this purpose.  Then, after the value of the marital estate is determined, the court should consider whether the overall value of the spouse's entire "separate property" has been subject to an increase or decrease in value, or whether that property has been depleted for marital purposes, so as to determine an equitable and just division of the marital estate.  It is for the purpose of dividing the marital estate, and not for the purpose of evaluating that estate, that Section 14-10-113(1)(d) requires that the overall increase or decrease in value of a spouse's separate property be considered.  Here, however, the dissolution court determined the increase in value of husband's separate property, as a whole, in arriving at the value of the marital estate.  From the figure representing several assets' increase in value, it subtracted the decrease in value suffered by several other assets and considered this "net" increase in all of the assets in determining the value of the estate to be divided.  This resulted in the court evaluating the existing marital estate at a figure substantially lower than would have been computed by a straightforward application of Section 14-10-113(4).  This does not mean, necessarily, that, in light of all the circumstances to be considered, the court's division of property here was inequitable. However, because the court's division order was based upon a miscalculation of the value of the marital estate, a remand to the court for its reconsideration of this issue is required....".

 

[25]Black's Law Dictionary, revised fourth edition

[26]In In re the Marriage of Renier, 854 P.2d 1382 (Colo. App. 1993) the Court of Appeals agreed with the wife that the trial court improperly calculated the parties' marital property without requiring the husband to trace his ownership of stocks and options he owned at the time of the marriage.  "Thus, apart from the issue of appreciation in value during the marriage, the additional 1,534 shares potentially could be classified as husband's separate property.  However, to retain its separate character, premarital property must be traceable to specific assets."

[27]In In re the Marriage of Stedman, 632 P.2d 1048 (Colo. App. 1981) the Court of Appeals states "The presumption is that property acquired during the marriage at issue is marital.  Section 14-10-113 (3), C.R.S. 1973.  And while a party may trace property acquired during the marriage to have been purchased with his separate property, thus maintaining its separate property character, the husband has failed to do so here as to the claimed $40,000 in savings."

[28]In In re the Marriage of Van Genderen, 720 P.2d 593 (Colo. App. 1985) the Court of Appeals agreed with the husband that the trial court erred in finding that the note, certain liquid assets, and an automobile were marital property rather than property acquired in exchange for pre-marital property.  The Court of Appeals agreed that the husband had overcome the statutory presumption that these assets are marital because he has traced these assets to the parent company which was incorporated before the marriage.

[29]Black's Law Dictionary, revised fourth edition

[30]See spreadsheets following this section.

[31]Under the entity method, the net unrealized losses for the brokerage account are $0 ($50,000 in unrealized gains less $50,000 in unrealized losses).

[32]In In re the Marriage Burford, No. 93CA1798 and No. 93CA2070 (Colo. App. 1997) the Court of Appeals stated that "the dissolution court should first add to the marital estate the amount of increase during the course of the marriage, if any, in each asset that was owned by each party before the marriage.  For this purpose, any asset suffering a decrease in value should be disregarded."

[33]Since Stocks A and B have not changed form during the marriage, they could presumably be adequately traced by comparing the brokerage statement at the date of marriage with the brokerage statement at the date of divorce.

[34]Since Stocks A and B have not changed form during the marriage, they could presumably be adequately traced by comparing the brokerage statement at the date of marriage with the brokerage statement at the date of divorce.

[35]If the court can be convinced that the separate and marital component of the limited partnership purchase as determined under the strict entity tracing approach tracing is not accurate, presumably, the asset tracing will fail to "uncommingle" the separate and marital components of the purchase.

[36]In In re the Marriage of Renier, 854 P.2d 1382 (Colo. App. 1993) the Court of Appeals agreed with the wife that the trial court improperly calculated the parties' marital property without requiring the husband to trace his ownership of stocks and options he owned at the time of the marriage.  "Thus, apart from the issue of appreciation in value during the marriage, the additional 1,534 shares potentially could be classified as husband's separate property.  However, to retain its separate character, premarital property must be traceable to specific assets."

[37]In In re the Marriage of Stedman, 632 P.2d 1048 (Colo. App. 1981) the Court of Appeals states "The presumption is that property acquired during the marriage at issue is marital.  Section 14-10-113 (3), C.R.S. 1973.  And while a party may trace property acquired during the marriage to have been purchased with his separate property, thus maintaining its separate property character, the husband has failed to do so here as to the claimed $40,000 in savings."

[38]Rule 26.2 is reproduced in Appendix 4 of this book.

[39]Rule 16.2 is reproduced in Appendix 5 of this book.

[40]Form 21.2 Pattern Requests for Production of Documents (Domestic Relations) is reproduced in Appendix 7 of this book.

[41]Form 20.2 Pattern Interrogatories (Domestic Relations) is reproduced in Appendix 6 of this book.

[42]Also see Forms 20.2 and 21.2, and documentation to be provided under Rule 16.2 reproduced in the appendixes of this book.

[43]Black's Law Dictionary, revised fourth edition, defines preponderance as "Greater weight of evidence, or evidence which is more credible and convincing to the mind.  That which best accords with reason and probability.  The word preponderance means something more than "weight"; it denotes superiority of weight; or outweighting."

[44]See Appendix page 10 for written report standards under the Colorado Rules of Civil Procedure.