In Texas, we characterize property as either separate or community or mixed. Separate property is anything that a spouse owns that was owned or claimed by that spouse before marriage, given to the spouse as a gift or as a result of someone's death, and awards in personal injury suits except for that part of the award that is specifically identified as being compensation for loss of earning capacity during the marriage.1Tex. Family Code § 3.002. Community property is everything that is not separate property.2Tex. Family Code § 3.003(a). As we work through the tracing examples below, it's important to keep those distinctions in mind. Separate Property is property that satisfies a narrow definition and Community Property is everything else.

Some Methods for Discerning Separate from Community Property

Mixed-character property is property that is partly separate and partly community. If spouses own mixed-character property when their marriage ends, they must determine how much of the mixed property is separate and how much is community.

(Related: Information Gathering; Property Division)

There are several ways of doing this when dealing with financial accounts.

Beginning Balance is Separate, All Else is Community

The simplest way is to take the balance in the account as of the date of marriage and characterize that as the separate property of the account owner and characterize the rest as community property. If the beginning balance is ascertainable, either from a statement, another document, or some agreeable heuristic, this method will yield a result with a simple subtraction operation:

Balance on Date of Divorce     $150,000
Balance on Date of Marriage   -$ 40,000
                              ---------
Community Property             $110,000
Separate Property              $ 40,000

There are several shortcomings to this approach, among them:

  1. It assumes that there have been no withdrawals during the marriage that ever reduced the account balance below the balance as of the date of marriage, i.e. that the account never fell below $40,000.
  2. It assumes that all unrealized capital gains and losses are attributable to the community portion of the account. In other words, the separate property component is locked in value and never goes up or down.
  3. It assumes that funds contributed during the marriage were invested in the same assets as those held on the date of the marriage. If this is a cash account, that's a fair assumption. If it contains investments, such as stocks or mutual funds, it's an assumption worth testing.

Beginning Balance is Numerator of an Allocation Fraction

The next simplest method for discerning separate from community funds in the account is to create a fraction:

  1. The numerator of which is the balance on the date of marriage; and
  2. The denominator of which is the sum of the contributions made to the account during the marriage (do not include unrealized capital gains--just add up the contributions) and the balance as of the date of marriage.

Taking our last example, assume the account had $40,000 on the date of marriage; that the account owner had made contributions totaling $60,000 during the marriage. The separate property portion would be:

Numerator:
    Balance on the date of marriage              $40,000

Denominator
    Sum of contributions during the marriage     $60,000
    Balance on the date of marriage             +$40,000
                                                --------
    Denominator                                 $100,000

Separate property fraction: $40,000 / $100,000 = 40%

Ending Balance                                  $150,000
Separate property fraction                         x  40%
                                                --------
Separate Property                               $ 60,000
                                                ========

Community (all that is not separate):
    Ending Balance                              $150,000
    Less: Separate Property                    -$ 60,000
                                               ---------
    Community Property                           $90,000
                                               =========

This method is more accurate than the prior method because it prorates the unrealized capital gains between the separate property and community property estates. If all the account investments generated an even rate of return over the duration of the marriage, e.g. a cash account paying the same rate of interest over the course of the marriage, this method is good enough.

It, too, has some shortcomings and complications:

  1. You'll need more than the beginning balance on the account--you'll need every statement for the account during the marriage. However, if the account received deposits in the same amount every month or if it is a 401(K) and the account owner has copies of the W-2's issued by the sponsoring employer during the marriage, you can determine the contributions from that information.
  2. It assumes that there have been no withdrawals during the marriage that ever reduced the account balance below the balance as of the date of marriage, i.e. that the account never fell below $40,000.
  3. It assumes that funds contributed during the marriage were invested in the same assets as those held on the date of the marriage. If this is a cash account, that's a fair assumption. If it contains investments, such as stocks or mutual funds, it's an assumption worth testing.

Detailed Tracing

The most accurate way to determine what is separate and what is community is to do a transaction-by-transaction tracing of the account. This will require every single statement from the date of marriage through the end of the period being traced. If the marriage lasted more than seven years, it may be impossible to get all these statements unless the account owner kept them all.

Here's a simple example of tracing an account:

Assume the account had a balance of $40,000 on the date of marriage. Construct a table like this:

Date Event Amount SP Alloc CP Alloc SP Balance CP Balance SP %
12/31/2010 Opening Balance $40,000 $40,000 $40,000 $0 100.00%

The columns have these meanings:

  1. Date is the date of the transaction. Here, the last balance available prior to the Jan 3, 2011 marriage is the 12/31/2010 end of year statement showing a balance of $40,000.
  2. Event is a description of what happened on that date. Here, it is the "Opening Balance."
  3. Amount is the amount of the transaction where additions are positive numbers and withdrawals are negative numbers.
  4. SP Alloc is the amount of the transaction that is allocated to the Separate Property estate. Because this was acquired before marriage, the entire $40,000 opening balance is allocated to separate property.
  5. CP Alloc is the amount of the transaction that is not allocated to Separate Property.
  6. SP Balance is the running balance of the separate property interest.
  7. CP Balance is the running balance of the community property interest.
  8. SP % is the percentage of the account that is separate property: [SP Balance] / [SP Balance + CP Balance].

Now assume that we have a quarterly statement showing that between 01/01/2011 and 03/31/2011, the account owner contributed $3,000 and that the final account value as of 03/31/2018 was $43,500. This information would be added to the table like this:

First, add the contributions to the table. Here we assume the contributions came from income earned during the marriage and not from any gift source:

Date Event Amount SP Alloc CP Alloc SP Balance CP Balance SP %
12/31/2010 Opening Balance $40,000 $40,000 $40,000 $0 100.00%
03/31/2011 2011Q1 Contributions $3,000 $3,000 $40,000 $3,000 93.02%

If the ending balance is $43,500 and we have contributions of $3,000, the remaining balance must be unrealized capital gains, calculate as follows:

03/31/2011 Ending Balance        $43,500
12/31/2010 Beginning Balance    -$40,000
                                --------
           Account Growth        $ 3,500
           Less: Contributions  -$ 3,000
                                --------
           Unrealized gains      $   500
                                ========

Thus, we have $500 to allocate between the separate property and community property balances, which we will do by applying the SP % fraction from the previous line in the table (93.02%):

Unrealized Gains                $ 500.00
SP %                           x   93.02%
                               ----------
Separate property portion       $ 465.10
                               ==========

Unrealized gains                $ 500.00
Less Separate property portion -$ 465.10
                               ---------
Community property portion      $  34.90
                               =========

Those allocations will appear in our table like this (rounded to keep the math simple):

Date Event Amount SP Alloc CP Alloc SP Balance CP Balance SP %
12/31/2010 Opening Balance $40,000 $40,000 $40,000 $0 100.00%
03/31/2011 2011Q1 Contributions $3,000 $3,000 $40,000 $3,000 93.02%
03/31/2011 2011Q1 Gains $500 $465 $35 $40,465 $3,035 93.02%

You'll note that in our table, the SP % number did not change. It did change deep behind the decimal, but not enough to make a difference.

Now assume that over the next quarter, the account owner contributes another $3,000 but that the ending balance is $45,000. Start by entering the contributions:

Date Event Amount SP Alloc CP Alloc SP Balance CP Balance SP %
12/31/2010 Opening Balance $40,000 $40,000 $40,000 $0 100.00%
03/31/2011 2011Q1 Contributions $3,000 $3,000 $40,000 $3,000 93.02%
03/31/2011 2011Q1 Gains $500 $465 $35 $40,465 $3,035 93.02%
06/30/2011 2011Q2 Contributions $3,000 $3,000 $40,465 $6,035 87.02%

Next, calculate the gain or loss on the account holdings:

06/30/2011 Ending Balance        $45,000
03/31/2011 Ending Balance       -$43,500
                                --------
           Account Growth        $ 1,500
           Less: Contributions  -$ 3,000
                                --------
           Unrealized loss       $ 1,500
                                ========

Whoops. The market gives and the market takes. We lost $1,500 in value during this period. The loss is allocated between the separate property and community property portions just like before:

Unrealized Loss                 $ 1,500.00
SP %                           x     87.02%
                               -----------
Separate property portion       $ 1,305.30
                               ===========

Unrealized Loss                 $ 1,500.00
Less Separate property portion -$ 1,305.30
                               -----------
Community property portion     -$   194.70
                               ===========

Again, for the purpose of this article, we'll round the numbers and add them to the tracing spreadsheet like this:

Date Event Amount SP Alloc CP Alloc SP Balance CP Balance SP %
12/31/2010 Opening Balance $40,000 $40,000 $40,000 $0 100.00%
03/31/2011 2011Q1 Contributions $3,000 $3,000 $40,000 $3,000 93.02%
03/31/2011 2011Q1 Gains $500 $465 $35 $40,465 $3,035 93.02%
06/30/2011 2011Q2 Contributions $3,000 $3,000 $40,465 $6,035 87.02%
06/30/2011 2011Q2 Losses -$1,500 -$1,305 -$195 $39,160 $5,840 87.02%

Finally, let's illustrate two withdrawals from the account. One that benefits the community estate and one that benefits the account owner's separate property estate.

First, the account owner takes a $1,000 withdrawal for some purpose that benefits the community, say to purchase a hot water heater for the community property marital residence. There is a presumption that when a withdrawal is made, it comes from the community portion of the account ("community out first").3Sibley v. Sibley, 286 S.W.2d 657 (Tex. Civ. App. Dallas 1955, writ dism'd)(per curiam). The logic of this case is that the person controlling the account withdraws his money first leaving money entrusted to him in the account. Note the date of the opinion. It's important to recall the quasi-trust principles of this case rather than mindlessly chant the "community out first" mantra. Where the withdrawal benefits the community estate, that's a fair assumption. This withdrawal would affect our tracing schedule like this:

Date Event Amount SP Alloc CP Alloc SP Balance CP Balance SP %
12/31/2010 Opening Balance $40,000 $40,000 $40,000 $0 100.00%
03/31/2011 2011Q1 Contributions $3,000 $3,000 $40,000 $3,000 93.02%
03/31/2011 2011Q1 Gains $500 $465 $35 $40,465 $3,035 93.02%
06/30/2011 2011Q2 Contributions $3,000 $3,000 $40,465 $6,035 87.02%
06/30/2011 2011Q2 Losses -$1,500 -$1,305 -$195 $39,160 $5,840 87.02%
09/30/2011 2011Q3 Withdrawal - Hot water heater -$1,000 -$1,000 $39,160 $4,840 89.00%

Next, the account owner takes a $1,500 withdrawal to pay a paramour's rent. (Calm down, it happens.) This transaction clearly did not benefit the community estate. The account owner might try to slip this in using the "community out first" principal, but here the other spouse would contest that "community out first" does not apply--why would you allocate a paramour's living expenses to the community? In this case, we'd allocate that withdrawal against the separate property portion of the account like this:

Date Event Amount SP Alloc CP Alloc SP Balance CP Balance SP %
12/31/2010 Opening Balance $40,000 $40,000 $40,000 $0 100.00%
03/31/2011 2011Q1 Contributions $3,000 $3,000 $40,000 $3,000 93.02%
03/31/2011 2011Q1 Gains $500 $465 $35 $40,465 $3,035 93.02%
06/30/2011 2011Q2 Contributions $3,000 $3,000 $40,465 $6,035 87.02%
06/30/2011 2011Q2 Losses -$1,500 -$1,305 -$195 $39,160 $5,840 87.02%
09/30/2011 2011Q3 Withdrawal - Hot water heater -$1,000 -$1,000 $39,160 $4,840 89.00%
09/30/2011 2011Q3 Withdrawal - Paramour rent -$1,500 -$1,500 $37,660 $4,840 88.61%

Differences Between Tracing Methods

Now assume that our ill-fated marriage ended on September 30, 2011 with no further transactions into the 401(K).

# Method Separate Property Community Property SP %
1 Beginning Balance is Separate, All Else is Community $40,000 $2,500 94.12%
2 Beginning Balance is Numerator of an Allocation Fraction $36,957 $5,543 86.96%
3 Detailed Tracing $37,660 $4,840 88.61

Method #1 failed to allocate the gains and losses between the two marital estates. Had there been no losses, Method #1 would have allocated all the unrealized capital gains to the community. Here, we had capital losses which should be proportionately distributed between the marital estates but instead were 100% allocated against the community estate. This method also failed to recognize the equity in charging to the owner's separate property the $1,500 withdrawal for paramour rent.

Method #2 came close and if there had been no withdrawals, it would have been exactly the same as detailed tracing. However, there were withdrawals and this introduced some inaccuracy in the allocation.

Method #3 is exactly right (once the parties stop arguing about how to allocate the withdrawals), but would have required the most information in terms of detailed statements of all three methods.

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