How Does Division of Property and Debt Work During Divorce?

The dissolution of a marriage is never easy. Divorce not only has deep emotional and psychological impact, but its financial ramifications can dictate how the future plays out for both people involved.  

Dividing the family’s property during divorce can be quite complicated. This holds especially true if there are significant assets involved - houses, retirement and pension plans, stocks, deferred compensation, brokerage accounts, businesses, professional practices, licenses, rental properties and a lot more. Add to this the debt acquired during the marriage that has to be divided.

Even under the most amenable separations, decisions on who gets what and who pays for which can be quite a challenge. And it’s much worse, of course, if the divorce is contentious.

Division of Property and Debt in California

California is classified as a “Community Property’ state and is one of only 9 states that recognize community property law. Under this law, both spouses are treated as equal co-owners of both property and debt acquired during marriage. 

In a divorce, the court will rule that community property and debts be divided equally between the spouses in divorce. While it is not always possible to divide all assets and debts in half (like in the case of a family home, for example), the ultimate result is an equal distribution.

Debts may or may not be equally divided depending on several determining factors, including the amount of assets each spouse receives. A larger portion of the debt may be assigned to the spouse who receives more property. As an example, if one spouse retains the marital home, he or she may be required by law to assume the mortgage. However, the other spouse may agree to pay the mortgage in exchange for not paying alimony.

There are exceptions to the Community Property Law:

1)   Prior arrangement between spouses on how properties and assets will be divided like in the case of a prenuptial agreement, for instance

2)    If the value of the community debt exceeds the value of the community assets. For this, unequal division of debts is allowed with the excess debts assigned to the spouse who is in a better financial situation to pay them. 

However a couple decides to divide properties or debts - be it on their own or via court decision, there are 3 crucial steps to the process:

1)    Determination of nature of properties or debts - marital (community) or separate

2)    Agreement on value of marital or community property

3)    Decision on how to divide the property or debt

Community vs Separate Property or Debt

In order to better understand how property is divided, it helps to know how properties are classified. It is important to note that properties mean not only real properties but also include other assets, that are easy to overlook.  Some examples are:

  • Tax refunds 

  • 401(k)s, 

  • IRAs and other retirement plans, 

  • Deferred compensation, 

  • Stock options, restricted stocks and other equity, 

  • Bonuses and commissions, 

  • Country club memberships, 

  • Annuities and life Insurance, 

  • brokerage accounts such mutual funds, stocks, bonds, etc; 

In California, there are 3 recognized types of property classifications for married couples:

1)    Community Property.  California law defines community property as “all property, real or personal, wherever situated, acquired by a married person during the marriage while domiciled in this state.” 

2)   Quasi-community Property. Much like the above, quasi-community property are those owned or acquired in another state prior to a married couple’s move to California. Under California law, this property is treated like community property.

3)   Separate Property.  The third classification refers to property or properties acquired before the marriage OR after the divorce process. This is not included in the equal division of properties. The following are considered separate properties:

    a)    Any property owned by either spouse prior to the marriage;

    b)    An inheritance received by either spouse before or after the marriage;

    c)    A gift received by the husband or wife from a third party;

    d)    Payment received for pain and suffering portion in a personal injury judgment

Debts are similarly classified as Community Debt or Separate Debt. Community debts are those incurred after the date of marriage. These debts belong to both spouses equally even if only one spouse incurred them. 

On the other hand, Separate debts are those incurred before the marriage or after separation. These belong only to the spouse that incurred them.

It Is Not All Cut and Dried …. The Process Can Be Complicated

The division of properties and debt is a complicated area of law because not everything is black or white. Even determination of what constitutes community or separate property and debt can become muddled. 

For instance, a spouse may unintentionally change a separate asset into a community asset by “co-mingling” separate property with marital property. This can happen, for example, to a house that was owned by one spouse. If both spouses pay the mortgage and other expenses on it, it becomes a marital property. Or in the case of a premarital bank account belonging to one spouse - it likewise becomes community property if the other spouse makes deposits to it.

There are also certain types of assets that are partially community and partially separate. This can happen if one spouse owns a business or other asset to which the other actively contributed either by labor input or funds during the marriage. 

The examples above show how things can get complicated and convoluted. In cases where there are a lot of assets and debt involved, hiring a good divorce financial planner can help sort things out. 

In part 2 of this article, we continue with information on steps you can take to protect yourself financially before and during divorce.  Click here to read it.

Tags: community debt, community property. joint property, debt division, property division, debt responsibility, financial responsibility, divorce property division, divorce debt

Filed Under: Divorce Tips

This information is not intended to be a substitute for seeking legal advice from an attorney. For legal or tax advice please seek the services of a qualified attorney and/or qualified tax professional.

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