We frequently represent clients who have engaged in some type of transaction with his or her spouse during the marriage that inadvertently causes them to lose certain rights to property unknowingly. This often happens in the context of acquiring or refinancing a home.
Is It a Loan or a Gift?
When a home is acquired, sometimes one of the parties’ parents will contribute money towards the down payment. As part of the mortgage lender’s underwriting requirements, the parents are typically required to sign a “gift letter” representing to the lender that the money they are contributing to the down payment is in fact a gift to the couple and not a loan that needs to be repaid. Often, however, the understanding between the parties and the parents making the “gift” is that it is really a loan that needs to be paid back. The dispute between the parties about whether they have a debt or received a gift comes to light in their divorce when determining how the home equity is going to be allocated between them. The child of the parents who made the gift will contend it was not really a gift but a loan and their parents need to be paid back. That debt should be recognized as a community debt in the divorce. The other spouse will contend it was a gift that does not need to be paid back and rely on the gift letter. If there is no documentation other than the gift letter it is almost 100% certain that a judge is going to find that this was a gift and not a loan. If a real loan is intended, then the parents making the loan and/or the child who wants his or her parents to be paid back needs to be sure to properly document the transaction as a loan with a signed promissory note or other documents that establish the parties’ real intentions concerning the transaction. Payments made on the debt during the marriage can also be critical.
Refinancing Transfers
When a home is refinanced, inadvertently sole property rights may be lost. It is not uncommon for one of the parties to own a home at the time of marriage which is titled just in their name. The newly married couple move into that home and establish it as their marital residence. If they seek to refinance the home, the lender will typically require that title be transferred to both parties and both parties sign loan documents obligating both on the loan. If title remains held jointly at the time the parties file for divorce, that home is going to be deemed community property. This is regardless of whether there may have been substantial equity in the property before the marriage or that the person did not intend to make a gift of that equity to the other person.
If one of the parties has bad credit during a refinance a mortgage broker may suggest that title be transferred to only one of the parties and then that one party qualifies for the loan. A quit claim deed may be executed, although it is also possible for a disclaimer deed to be executed. A person signing a disclaimer deed does not realize they may be walking away from their share of the equity in the home. We see transactions where this happens and the person whose rights have been lost says that there were discussions about transferring title back to both parties jointly after the loan closed, but often that follow through does not occur.
Estate Plan Transfers
Inadvertent transmutation of separate property to community property may happen when the married couple forms or modifies their estate plan. Trust agreements typically have provisions that address the characterization of property transferred to the trust as separate property or community property, and whether property transferred to the trust will maintain its character or not. While it is possible to challenge the transmutation of property from separate to community by virtue of signing a trust agreement, people would be far better served to recognize that their property rights could be affected by the terms of the estate plan and each party should have separate counsel when anyone’s separate property is going to be included as part of an estate plan.
Co-mingling
The last situation where inadvertent transmutation frequently occurs is when there is “co-mingling”. Co-mingling describes a situation where separate property assets and community assets are put together. The typical situation is with a bank or brokerage account, owned prior to marriage or funded with assets inherited during the marriage. Following or during the marriage, transactions may occur in which community funds are introduced into that account. Arizona has a very strict law about direct tracing in order to maintain the separate property character of such an account. This law produces results that are contrary to what people might intuitively think. For example, if someone had $1 million in assets in his or her personal brokerage account before marriage and then during the marriage $100,000 of marital assets were contributed to it, it is reasonable to assume that because most of the money in the account was separate property that those separate funds would remain separate property if the parties were to divorce. However, that is not the case as in many cases numerous transactions happen between the time the community money was introduced into the account and when a divorce is filed. Years later it becomes impossible to directly trace the separate assets. It is important to keep accounts separate and open new accounts that will hold community assets. Notably the co-mingling issue does not apply to retirement accounts.
Summary
The bottom line is that everyone should be sensitive to the impact on their property rights when acquiring or refinancing a home, when they are involved in creating an estate plan and how they maintain accounts or assets that were acquired prior to marriage or given to them during the marriage.
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