Under Tennessee law, marital property is subject to property division and separate property is excluded from property division in a divorce. The underlying factor in this distinction is whether the increase in value between the date of marriage and the date of divorce resulted from efforts by a spouse, known as active appreciation, or from external (economic, market, industry) forces, known as passive appreciation. While these concepts seem simple, the classifications are only part of the story.
Classification of Marital and Separate Property
Tennessee Code 36-4-121 defines marital property as “all real and personal property, both tangible and intangible, acquired by either or both spouses during the course of the marriage up to the date of the final divorce hearing.”
The same code section defines separate property as “all real and personal property owned by a spouse before marriage, property acquired in exchange for property acquired prior to marriage, property acquired by a spouse at any time by gift, bequest, devise or descent, etc.”
Can a Marital Asset Ever Become Separate or Can a Separate Asset Ever Become Martial?
Let’s examine this question in the context of a business or business interest as an example. If a couple or spouse starts a business or acquires a business interest during the marriage, then it would be classified as marital. Any appreciation or increase in value of the business or business interest would also be classified and remain a marital asset.
Conversely, if a spouse starts a business or business interest prior to the date of marriage or acquires it by gift, bequest, devise or descent, then initially that business or business interest would be classified as a separate asset. What happens to that business or business interest if the value changes during the marriage? The increased value or appreciation of a business or business interest could be classified as marital or separate. How is this possible?
If both spouses contribute to the preservation and appreciation of a separate property business or business interest and the contribution is “real” and “significant,” then the appreciation (increase in value) of the business or business interest would be determined to be a marital asset and subject to division. This is known as active appreciation.
If, on the other hand, both spouses do not contribute to the appreciation in value, there is no appreciation in value, or the appreciation is attributable to passive forces, such as inflation, then the separate property business or business interest would remain separate.
The following steps assist the financial analyst during the process:
- Is the business, or business interests, marital or separate?
- a. Compare the formation or inheritance date(s) to date of marriage.
- If the answer to (1) concludes pre-marital, separate property, value the business as of the date of marriage as a starting point. Then, value the business as of the date of divorce (or as close to as possible).
- If the value has increased from the date of marriage to the date of divorce, a determination of active (marital) versus passive (separate) shall commence.
What Must Be Demonstrated
Tennessee code states that the substantial contribution of the non-business spouse “may include, but not be limited to, the direct or indirect contribution of the spouse as a homemaker, wage earner, parent or financial manager, together with such other factors as the court having jurisdiction thereof may determine.”
A non-business owner spouse must be able to demonstrate two things in order for appreciation of a separate property business or business interest to become a marital asset: substantial contribution of both spouses contributing to the appreciation,and actual appreciation in the value of the business or business interest during the marriage. Most often, a valuation of the business or business interest at the date of marriage and also the date of filing would be required among other things to try and support this claim.
This article has used a business or business interest to illustrate the concepts of martial vs. separate assets and also the appreciation in value. It should be noted that there could be potentially other considerations for these same issues with other assets, such as investment properties or passive assets (401Ks, etc.).
Conclusion
A financial expert, specifically one with expertise in business valuation, is vital in the determination of active appreciation (separate) versus passive appreciation (marital).
The professionals of Mercer Capital can assist in the process. For more information or discuss an engagement in confidence, please contact us.
Originally published in Mercer Capital’s Tennessee Family Law Newsletter, Third Quarter 2018
