Chapter 2 - § 2.1 • INTERESTS EXCLUDED OR LIMITED BY PROPERTY DIVISION STATUTE

• Jurisdiction: Colorado

§ 2.1 • INTERESTS EXCLUDED OR LIMITED BY PROPERTY DIVISION STATUTE

The inclusion of beneficial interests in third-party settled trusts in the divisible pool will not arise, or is unlikely to arise, in states that exclude increases in the value of separate property from property divisions.¹

§ 2.1.1—California Statute

Separate property of a married person is defined by California statute to mean "[a]ll property owned by the person before marriage"; "[a]ll property acquired by the person after marriage by gift, bequest, devise, or descent"; and "[t]he rents, issues, and profits [from such property]."² "[A]ll property, real or personal, wherever situated, [except separate property], acquired by a married person during the marriage while domiciled in [California] is community property."³

On divorce, unless otherwise agreed to in writing or stipulated in court, the community estate is divided equally.⁴ The California statutory regime does not permit divorce courts to award the separate property of one spouse to the other.⁵ Thus, the determination in a California divorce proceeding that an interest in a third-party settled trust constitutes separate property, or does not constitute property in any respect for purposes of property division, is typically unnecessary because the appreciation of the trust assets, even if separate property, may not be divided by the court.⁶ This also appears to be the case in Arizona, Nevada, and New Mexico.⁷

Washington Law Compared

Separate property in Washington, a community property state, includes property acquired before marriage; property acquired by gift, bequest, devise, or descent; and rents, issues, and profits thereof.⁸ In this respect, Washington law is similar to that of California, but, unlike California law, all of the property of the parties is subject to division in Washington.⁹ Whether an interest in trust is potentially subject to division in Washington would therefore turn on whether the interest in trust constitutes "property" under the property division statute. "Property" under the Washington statute is defined broadly, "'embracing everything that has exchangeable value, and every interest or estate which the law regards of sufficient value for judicial recognition.'"¹⁰

Washington appellate court authority indicates that such divisions are possible.¹¹

§ 2.1.2—New York, New Jersey, And Florida Law

At first glance, New York's equitable division statute would seem to exclude interests in third-party settled trusts from a property division. The relevant statutory provisions state that marital property shall be "distributed equitably between the parties, considering the circumstances of the case and of the respective parties"¹² and that "[s]eparate property shall remain such" (in other words, separate property shall not be divided).¹³

Marital property is defined in New York as "property acquired by either or both spouses during the marriage . . . regardless of the form in which title is held."¹⁴ Separate property is defined as "property acquired before marriage or property acquired by bequest, devise, or descent, or gift from a party other than the spouse."¹⁵ Also included in the definition of separate property in New York is "property acquired in exchange for or the increase in value of the separate property, except to the extent that such appreciation is due in part to the contributions or efforts of the other spouse."¹⁶

In most instances, it would seem that appreciation of trust assets will not be caused in any part by the contributions or efforts of the non-beneficiary spouse. Where trust assets consist entirely of passive-type assets, or where the trust is administered and managed by neither of the spouses, the New York statute would seem to place the trust beyond the equitable division power of the court.

But not every third-party settled trust appears to be beyond the reach of a New York court's equitable division power. In Hartog v. Hartog,¹⁷ a portion of the appreciation in the husband's closely held business interests, which constituted his separate property, was transmuted to marital property. The husband claimed his activities in the businesses amounted to "paper participation" only, that his involvement in the businesses was "meager" and had no actual impact on the appreciation in the value of the businesses.¹⁸ The husband's brother or others had primary responsibility for the day-to-day management and operation of the businesses. Although the husband was an officer and director of the corporations, he worked full time in a different business.¹⁹

The court held that transmutation of appreciation of the husband's separate property interests occurred and that a non-titled spouse need not prove a definite and direct nexus between the titled spouse's activities and the appreciation. The wife, as the non-titled spouse, was a "traditional homemaker, serving in roles of spouse, parent, housekeeper and hostess."²⁰ Citing Price v. Price²¹ as precedent, the court determined that the non-titled spouse's indirect contributions in those roles were a sufficient nexus to cause appreciation of the separate property to constitute marital property.²²

Beneficiaries of trusts frequently serve as trustees, and it is not uncommon for trusts to hold assets that require active management and participation. In an effort to document bona fide business purposes, the organizational documents of many closely held entities, such as family limited partnerships, attempt to negate the inference that the entity is passive in nature. Moreover, in response to federal estate tax developments beyond the scope of this book, it is often preferable for younger family members to serve as the general partners and managers of family limited partnerships and family limited liability companies. Thus, the structure of a closely held entity, interests of which are held in trust, in the most advantageous way for federal transfer tax purposes has the potential of subjecting an interest to the claim of...