Tracing Commingled Funds in Complex Divorces

When a marriage ends, one of the most contentious and complicated tasks is dividing the assets. It’s rarely as simple as splitting everything down the middle. For many couples, especially those in long-term marriages or with significant assets, the lines between what belongs to one person and what belongs to the marriage become blurred. This is particularly true when “separate” property, owned by one spouse before the marriage or received as a gift or inheritance, gets mixed with “marital” property acquired during the marriage. This mixing of funds is known as commingling, and untangling it requires a meticulous process called tracing.

What Is the Difference Between Separate and Marital Property in Virginia?

To grasp the concept of commingling, it’s first important to know how Virginia law categorizes property in a divorce. The court’s goal is to achieve “equitable distribution,” which means it will divide marital property in a way that is fair, though not always perfectly equal.

Separate Property: This belongs exclusively to one spouse and is generally not subject to division. Under Virginia Code § 20-107.3, separate property includes:

• All property, both real and personal, that a spouse owned before the marriage.
• Property acquired during the marriage as a gift from someone other than the spouse.
• Property acquired during the marriage through inheritance.
• Property acquired after the parties have separated.
• The increase in value of separate property, unless marital property or the personal efforts of either spouse contributed to that increase.

Marital Property: This is property that is subject to equitable distribution. It generally includes:

• All property acquired by either spouse during the marriage that is not separate property.
• The increase in value of separate property that is caused by the contribution of marital property or the personal efforts of either spouse. “Personal efforts” are defined as labor, effect, or industry that results in appreciation of the property.

Hybrid Property: This is property that is part marital and part separate. This often occurs when separate property increases in value due to contributions of marital funds or the active efforts of a spouse.

How Does Commingling Occur?

Commingling happens when separate property is mixed with marital property to the point where it becomes difficult to distinguish between the two. Once commingled, the separate property may lose its identity and be treated as marital property unless it can be effectively traced back to its original source.

Common examples of commingling include:

• Depositing Inheritance into a Joint Account: A spouse receives a $50,000 inheritance (separate property) and deposits it into a joint savings account that is used for household expenses.
• Using a Pre-Marital Savings Account for Marital Expenses: One spouse enters the marriage with a savings account containing $100,000. Over the years, the couple uses that account to pay for vacations, home renovations, and daily living costs.
• Paying Down a Mortgage on a Marital Home with Separate Funds: A spouse sells a rental property they owned before the marriage and uses the $75,000 in proceeds to make a large principal payment on the mortgage of the marital home.
• Investing Separate Funds into a Joint Portfolio: One spouse inherits stock and places it into a joint investment account, where it is later sold, and the proceeds are used to buy different stocks alongside marital funds.

What is Transmutation?

A related but distinct concept is transmutation. This occurs when the owner of separate property shows a clear intent to change its character into marital property. This can happen even without commingling. For instance, if a spouse owns a home before the marriage and, after marrying, retitles the deed into both spouses’ names, the law may presume they intended to gift the property to the marital partnership.

The key difference is intent. Commingling can be unintentional, a simple result of how a couple manages their finances. Transmutation requires a demonstrable act that shows the intent to convert separate property into marital property.

What is the “Source of Funds” Rule in Virginia?

Virginia courts apply the “source of funds” rule to untangle commingled assets. This rule dictates that the character of the property is determined by the character of the funds used to acquire it. The spouse claiming that a portion of an asset is separate property bears the burden of proving it by tracing those funds back to a separate source.

This means you must be able to show, with verifiable evidence, the journey of the separate funds. It’s not enough to simply state that you used inheritance money to help buy a marital asset; you must provide a paper trail that proves it.

What Is the Process of Tracing?

Tracing is the financial detective work of following the path of money or an asset from its separate origin through its various transformations into its current form. It is a methodical, evidence-based process that requires meticulous documentation.

The steps involved in tracing typically include:

• Identification: The first step is to identify the asset that is believed to be separate property. This could be a specific bank account, an investment, or a piece of real estate.
• Documentation: You must gather all relevant financial records. The more complete the documentation, the stronger your case will be.
• Analysis: A detailed analysis of the financial records is conducted to follow the flow of funds. This often involves creating spreadsheets or flowcharts to illustrate how the separate funds moved over time.
• Presentation: The findings are presented to the court in a clear and understandable format, often with the help of a financial professional like a forensic accountant.

What Kind of Evidence is Needed to Trace Commingled Funds?

The success of a tracing claim depends almost entirely on the quality of the evidence. The court will not rely on assumptions or vague recollections. You need concrete proof.

Essential documents for tracing include:

• Bank Statements: Complete statements for all relevant accounts, often going back years, are necessary to show deposits, withdrawals, and transfers.
• Investment Account Statements: These documents show the purchase and sale of securities, dividends, and cash movements.
• Real Estate Records: Deeds, closing statements (HUD-1s), and mortgage documents can prove the source of funds used for a down payment or paydown.
• Inheritance Documents: Wills, trust documents, and probate records can establish the existence and amount of an inheritance.
• Gift Letters or Affidavits: A letter from the person who gave a gift can help prove its nature as separate property.
• Tax Returns: These can provide supporting evidence for asset ownership and income.
• Appraisals and Valuations: Documents showing the value of an asset at a specific point in time are important.

What Are the Challenges in Tracing Different Types of Assets?

Tracing can range from relatively straightforward to incredibly complex, depending on the asset and how it was handled during the marriage.

• Bank Accounts: Tracing funds in a bank account becomes difficult when the account has been very active, with numerous deposits and withdrawals of both marital and separate funds. If a separate deposit is made and then small amounts are withdrawn for daily expenses over many years, it can be nearly impossible to argue that the original separate funds remain.
• Investment Accounts: With investment portfolios, dividends may be reinvested, stocks may be sold, and new ones purchased with a mix of separate and marital funds. Tracing requires analyzing each transaction to determine the character of the funds used.
• Real Estate: When separate funds are used for a down payment on a marital home, the tracing is often simpler. The challenge arises in calculating the return on that separate investment. The court must determine how much of the home’s appreciation is due to market forces (which would be passive growth to the separate interest) versus how much is due to marital contributions like mortgage payments or renovations.
• Retirement Accounts: If a spouse had a 401(k) or IRA before the marriage, the pre-marital balance is separate property. However, all contributions and earnings on those contributions made during the marriage are marital. A statement showing the account balance on the date of marriage is essential for tracing.
• Closely Held Businesses: Valuing and tracing interests in a family business is one of the most complex areas. It often requires determining the business’s value at the time of marriage and again at separation, and analyzing whether any increase in value was due to the active efforts of a spouse (marital) or simply market factors (passive/separate).

What is the Role of a Forensic Accountant?

In complex divorce cases involving significant or heavily commingled assets, a forensic accountant is an invaluable member of your legal team. These financial professionals have the specialized skills to perform detailed tracing analysis that can withstand scrutiny in court.

A forensic accountant can:

• Organize and Analyze Financial Data: They can sift through boxes of financial records to find the key pieces of evidence.
• Prepare Tracing Reports: They create clear, concise reports with supporting documentation that explain the flow of funds.
• Serve as an Expert Witness: A forensic accountant can testify in court to explain their findings and methodology, lending significant credibility to your claim.

While hiring a financial professional adds to the cost of a divorce, the value of a successful tracing claim—potentially protecting tens or even hundreds of thousands of dollars in separate property—often far outweighs the expense.

How Can You Protect Your Separate Property?

While it may be too late if you are already facing a divorce, there are steps individuals can take to protect separate property in the future:

• Keep Separate Assets Separate: The easiest way to avoid commingling is to maintain separate accounts for separate property. Do not deposit inheritance or gift money into joint accounts.
• Document Everything: Keep meticulous records of any transactions involving separate property. If you use separate funds for a marital purpose, document it clearly.
• Consider a Premarital or Postnuptial Agreement: These legal agreements can define what will be considered separate and marital property, which can save immense time and conflict should the marriage end.

Get the Support You Need with Olmstead & Olmstead

Disputes over commingled funds can make a complex divorce even more stressful. Protecting your separate assets requires a thorough understanding of Virginia law, meticulous preparation, and persuasive presentation of evidence.

At Olmstead & Olmstead, we are dedicated to helping families in Virginia navigate these complex issues. We have the knowledge to address the sophisticated financial matters that arise in high-asset divorces and can assist you in developing a strategy to trace and protect your property. We work to find practical and respectful solutions that safeguard your financial future.

If you are facing a child custody dispute involving religious differences or if you need to modify an existing order, we encourage you to reach out. We can help you assess your situation, understand your rights and obligations under Virginia law, and work towards a resolution that protects your child’s well-being and your parental relationship. Please contact us at 703-361-1555 to schedule a consultation.