Purchasers of Real Property Should Consider Community Property Rules

In the recent case of In re Marriage of Nevai and Klemunes, a marital dissolution proceeding, Martha J. Nevai (wife) contended the trial court erred in various orders of reimbursement to the community for spending related to wife’s separate real property. She also argued the trial court erred in setting spousal support and in refusing to award her attorney fees.

The Appellate Court agreed that the trial court erred in fixing the permanent spousal support award and in reimbursing John Klemunes (husband) for mortgage interest and property taxes on wife’s vacation home, and ordering that each side pay their own attorney fees.

Husband and wife were married in February 2003, and separated in August 2015.

Before the marriage, wife owned a cabin at Lake Tahoe (“Tahoe property”). She purchased the property as an empty lot in 1998 and built a house on it, spending approximately $289,000. The parties stipulated that at the time of the marriage, the Tahoe property was worth $525,000.

There was a mortgage on the property at the time of the marriage, and wife testified that the $1,800 mortgage payment, which included an escrowed amount for property taxes, was automatically paid each month from a joint bank account (i.e., community funds).

Between 2008 and 2015, husband and wife rented out the Tahoe property for the ski season (December through April) and occasionally during the summer. The rental income for the property would be deposited into the same joint bank account used to pay the mortgage and property taxes.

During the trial, wife testified that she, husband, and child would use the Tahoe property for recreation, typically about two times per month during the summer. She and child would often stay for a week, and husband would stay on the weekends. The family often spent the Fourth of July holiday there. Husband testified that between approximately 2007 and 2014, he spent only four holiday weekends at the Tahoe property each year, but wife and child would stay there more often during the summers.

Wife further testified that the value of the Tahoe property at the time of trial was $475,000 to $495,000, based on the opinion of a local real estate agent.

Husband testified that approximately $7,000 in improvements were made to the Tahoe property during the marriage, including adding a hot tub and an electrical connection, and installing new flooring. Husband explained that “We” made the improvements. Husband testified that the hot tub “[d]efinitely” made the property more marketable as a vacation rental property because “people kind of expect a vacation rental to have a hot tub.”

With respect to the Tahoe property, the court accepted the appraised value of $735,000. It also adopted Silva’s propertizer, with “various offsets and modifications.” Specifically, the court offset $105,000 of the community reimbursement for interest and property taxes, so as to reduce the equalization payment to zero.

Wife argued the trial court erred when it ordered reimbursement for the community’s payment of mortgage interest and property taxes on the Tahoe property. Wife argued a community that has received a pro tanto interest in separate property (which includes reimbursement for payment of the mortgage principal) is not also entitled to reimbursement for payment of property taxes on separate property.

In reply, husband argued that a community is entitled to reimbursement for payments used to discharge a spouse’s separate debts, including taxes and mortgages related to separate property.

The Appellate Court agreed with wife.

Where community funds are used to make payments on a property purchased by one of the spouses before marriage, ‘the rule developed through decisions in California gives to the community a pro tanto community property interest in such property in the ratio that the payments on the purchase price with community funds bear to the payments made with separate funds.This rule has been commonly understood as excluding payments for interest and taxes.” (In re Marriage of Moore (1980).)

This pro tanto interest is awarded to the community along with reimbursement for community funds used to reduce the mortgage principal or improve the property during the marriage. (In re Marriage of Marsden (1982).)

In other words, the community payments are similar to an investment and create a present property interest. Specifically, in calculating the community’s pro tanto interest, the following principles apply.

First, the separate property estate is credited with both premarital and postseparation appreciation in the value of the property.

Next, the community’s contributions to equity are considered.

Finally, the community’s interest in the property, expressed as a percentage, is multiplied by the appreciation in the property’s value during the marriage.

Given the nature of the community’s payments, courts have made clear that expenditures for interest and taxes must not be included when calculating the community’s interest in the separate property.

Such payments neither contribute to the capital investment nor increase the equity value of the property. Instead, expenditures for interest and taxes are more properly considered as expenses incurred to maintain the investment. Because they are not assets or debts of the community, they may not be considered by the court at dissolution. Moreover, if these items were considered to be part of the community’s interest, fairness would also require that the community be charged for its use of the property.

Interest and taxes paid on separate property should not be included in community interest calculation because “such expenditures do not increase the equity value of the property and therefore should not be considered in its division upon dissolution of marriage.

The Appellate Court concluded the trial court erred in determining the community was entitled to reimbursement in the amount of $176,951 for property taxes and mortgage interest related to the Tahoe property.

The judgment was reversed with respect to the award of reimbursement for mortgage interest and property taxes for the Tahoe property and corresponding calculation of the equalization payment.

LESSONS:

1.         The status of real property as separate property (i.e., property owned before marriage) should always be considered when getting married, and it is beneficial to enter into a prenuptial agreement to confirm the effect of using community property funds (i.e., earnings after marriage) to support the separate property.

2.         Unfortunately, divorce is a possibility in every marriage, and the spouses separate property interests should be confirmed by either a pre-nuptial agreement, or a post-nuptial agreement.