Appreciation of Separate Property
by Clifford J. Petroske, Esq.
There is nothing equitable about separate property in a divorce action. If you have it, you get to keep it – all of it – unless, of course, some part of it has changed into marital property. Only marital property – property acquired during the marriage – is divided between the spouses. Separate property is the narrow exception to the marital property rule, and is limited to the following categories: (1) property acquired prior the marriage; (2) inherited property; (3) gifts from third parties; (4) proceeds of personal injury awards; and (5) property acquired after the commencement of an action for divorce or the signing of a separation agreement.
Sometimes, separate property becomes marital property and therefore must be divided between the parties. There are numerous ways this can happen – for example, "transmutation" occurs when the title to separate property is changed to joint title and the asset becomes marital. A separate property asset can also lose its separate property character even without a change of title, as when it is "commingled" with marital funds, so that it is impossible to say what portion is the original separate asset. Finally, when separate property increases in value (appreciates), some or all of that appreciation can be classified as marital property.
Not all appreciation of separate property is marital. The courts have long distinguished between passive and active appreciation of separate property, and only active appreciation is considered marital property in which the non-titled spouse has an interest. Passive appreciation occurs when neither the titled spouse nor the non-titled spouse has made any active contribution that caused the asset to appreciate. For the appreciation to be active there must be some "nexus" or connection between efforts made by one of the spouses, and the increase in value of the asset. The non-titled spouse’s efforts need not directly contribute to the increase in value. Even indirect contributions will suffice, so long as the other spouse has made a direct contribution to the increase in value of the asset. In the seminal case Price v. Price, 69 NY2d 8, the New York Court of Appeals interpreted the equitable distribution statute to provide that where separate property has increased in value during the marriage because of the efforts of the titled spouse, the non-titled spouse has a claim to some of that appreciation through her "contributions or efforts," including being a parent and homemaker during the marriage.
Where separate property has experienced active appreciation the owner must make some provision to purchase the other party’s interest in the appreciated portion of the asset or he may lose it. Not directly, and not immediately, since the court lacks the power to distribute any part of a separate property asset, but some means of sharing the appreciated portion of the value of the separate property asset must be devised. The most direct method is a direction in the judgment of divorce to make a monetary payment. If unpaid, this will quickly lead to the issuance of a separate money judgment in favor of the non-titled spouse. Ironically, payment may be obtained by levy and execution (i.e., seizure and sale) on any property belonging to the other party – including the separate property asset. Of course, this is a worst case scenario. Usually, the separate property owner will opt for, or the court will direct, a trade of his/her interest in another, marital asset, to buy-out the non-titled party’s interest in the appreciated separate property asset. However, where there are no trade-able marital assets, and no cash available for a buy-out, enforcement of a money judgment may be the only option.
The doctrine of recoupment is related to separate property appreciation, except that it can be far more costly to the separate property owner. If the parties use marital funds to pay down a separate debt — i.e., a debt that existed prior to the marriage — the non-debtor spouse has a claim to "recoup" or get back an equitable portion of those funds expended. Usually, the claim is one-half of the funds expended, in the same way marital property is usually divided 50/50. In the typical example of a separate property residence with a mortgage, both of which pre-existed the marriage, payments made toward the mortgage during the marriage with marital funds can be re-couped from the separate property owner in the divorce action. However, it is quite possible for the recoupment claim to equal or exceed the value of the separate property, since the entire debt payment — including interest — is the subject of recoupment. In fact, in Markopoulos v. Markopoulos, 274 AD2d 457, the non-titled spouse obtained recoupment of two payment streams: First, one-half of the total monies expended during the marriage on mortgage payments for the separate property; and second, one-half of the marital monies used to pay for improvements on the separate property. At the end of the day, the husband kept his vacation home in Forestport as his separate property, but he owed his ex-wife over $41,000 for recoupment in a six year marriage.
Given the pitfalls that await the separate property owner, a well-drafted pre-nuptial agreement is essential. Among other features, a "pre-nup" will commonly have each spouse waive any interest in the other spouse’s separate property and all forms of appreciation. Since the law invites those contemplating marriage to make their own contract, it would be foolish not to. Perhaps the old adage said it best: An ounce of prevention is worth a pound of cure.