Often, one spouse brings into the marriage a home previously purchased and titled in his or her name, and with a loan attached. The home is the lender’s security for payment of the loan. After the wedding, the homeowner’s spouse moves in with the homeowner, and together they pay down the loan principal with community property earnings.
At some point bliss unravels, and the couple decides to separate. They agree that the spouse with title to the home will continue to reside there and the other spouse will move out. Neither party rushes to the courthouse to file for divorce, although eventually a divorce petition is filed, perhaps years after the date of separation. Post-separation, the spouse holding title continues to live in the home and makes all of the post-separation mortgage payments with his or her separate property earnings.
One of the questions answered by the appellate opinion in Marriage of Mohler* (“Mohler“) is whether a spouse bringing a mortgaged home into the marriage, and then paying down the mortgage loan principal with community property funds during the marriage, can be charged rent by the community estate while living there after the parties separate. The short answer is yes, surprisingly.
For reference, here are some legal concepts needed to understand the somewhat complex appellate opinion answering that question:
Except as otherwise provided by statute, all property, including real estate and personal property, acquired by a married person during the marriage while domiciled in California is community property. (Family Code section 760.) Separate property of a person includes all property owned by the person before marriage, all property acquired by the person during the marriage by gift, bequest (i.e., a gift of personal property in a will), devise (i.e., a gift of real estate in a will), or descent (i.e., received under the state laws of inheritance when no will exists), and the rents, issues, and profits of that property. (Family Code section 770(a).) Generally, the earnings and accumulations of a spouse after the date of separation are the separate property of that spouse. (Family Code section 771(a).)
In divorce or legal separation proceedings in California, unless the parties agree otherwise, the trial court is required to divide the community property equally between the spouses. (Family Code section 2550.)
Whenever one spouse brings into the marriage a home used as collateral for a mortgage loan, and the spouses’ community funds are used to pay down the loan during the marriage, the community estate gains an increasing beneficial interest in the home as the loan’s principal balance is paid down with community funds and equity grows. California law provides a formula with which to apportion the property’s value between the legal-title-holding spouse’s separate estate and (each spouse’s one-half of) the community estate’s beneficial interest. This is known in California family law as the Moore/Marsden rule. This rule apportions to the community estate a pro tanto community property interest that is at least an equitable interest, in the form of a reimbursement, if not a legal (title) interest.
In Marriage of Moore (1980) 28 Cal.3d 366, the community estate is awarded at the time of the division of the spouses’ property in a divorce or legal separation proceeding a dollar-for-dollar reimbursement in an amount equal to the community funds used to pay down the principal balance of the mortgage loan on property purchased by one spouse before the marriage. Additionally, the community estate is reimbursed for the pro tanto community property interest in the appreciation in value of the home during the marriage, calculated by the fraction of the total loan principal pay down with community funds creating equity in the property as the numerator and the purchase price as the denominator.
Two years after Marriage of Moore, Marriage of Marsden (1982) 130 Cal.App.3d 426 changed the calculation of the reimbursement to award any premarital appreciation to the spouse who purchased the property prior to the marriage but otherwise uses the same formula as Marriage of Moore. The community estate is reimbursed for its share of the appreciated value from the date of marriage to or near the time of trial unless the trial court orders that an earlier date after the parties’ separation is to be used instead. (Family Code Section 2552.)
Now, on to the appellate opinion in Mohler, which addresses husband Greg Mohler’s appeal from a creative argument brought at trial by wife Jodie Mohler to increase the percentage of the community’s beneficial interest (and therefore Jodie’s one-half share of that interest) in Greg’s home, based on his payment of the mortgage loan for six years after the parties’ separated with his separate property funds. Paying down the mortgage with separate property funds would logically only benefit Greg and not the community estate. The Riverside County trial court, however, agreed with Jodie’s argument.
Greg purchased the home for $168,000.00 before marriage. Because he purchased the property before marriage, the property was his separate property during the marriage. At the time of marriage, the home was worth $185,000.00. The parties lived in the home for 12 years prior to their separation, during which time they paid down the mortgage loan principal by $56,557.00 using community funds (remember that these funds were acquired during the marriage and not by way of gift or inheritance). Under the Moore/Marsden rule, this $56,557.00 in mortgage principal reduction during the marriage had to be reimbursed dollar-for-dollar to the community estate, half of which was Greg’s and half Jodie’s.
The mortgage principal pay down using community funds represented 33.6 percent of the purchase price [56,557/168,000 = 0.336] during the 12-year marriage through the date of separation. Hence, Greg and Jodie stipulated (agreed) at trial that the community estate acquired a 33.6 percent interest in Greg’s home.
During the marriage through the date of trial, the fair market value of the home increased from $185,000.00 to $530,000.00 for an equity increase of $345,000.00. To complete the Moore/Marsden rule’s formula, added to the $56,557.00 to be reimbursed was the value of 33.6% of the $345,000.00 in appreciated value, or $116,127.00, for a total reimbursement of $172,684.00 from Greg to the community estate. (Effectively, Greg owed Jodie a reimbursement of one-half of that amount or $86,342.00. This is clear enough, but now the trial court had to address Jodie’s argument.)
Greg continued to live in the home for another six years after he and Jodie separated and before their divorce proceedings were brought to trial, which would seem harmless enough. During this time, Greg paid the mortgage loan with his post-separation earnings, which were his separate property.
Jodie argued at trial that the community estate’s beneficial interest had increased above the 33.6 percent based on the six years after their separation while Greg paid down the mortgage principal with his separate funds. Jodie argued that, because the community had acquired a 33.6 percent interest, the community interest should grow as the equity grew. This argument seems remiss because the Moore/Marsden rule is based on the beneficial increasing as community funds, as opposed to separate property funds, pay down the principal balance. Greg continued to use his separate earnings pay down an additional $52,482.00 during the six years after the parties separated. According to Jodie, after the parties’ separation, the community’s beneficial interest grew to 64.9 percent. The trial court agreed and awarded the community the sum of $223,905.00 [$345,000.00 x 0.649] as the community’s beneficial interest in the appreciated value.
Greg appealed the decision, and the appellate court agreed with Greg that the trial court made a mistake in using the Moore/Marsden rule to apportion the increased value from Greg’s separate property earnings having further reduced the principal balance owed and increasing the equity: only when community funds are used to build equity can the community’s beneficial interest grow. After separation, the earnings and accumulations of a spouse are that spouse’s separate property. Jodie’s argument was flawed because no community funds were used to pay down the principal balance after the parties’ separation. Just as Greg’s use of separate property funds before the marriage (which reduced the principal balance and grew equity) did not increase the community’s interest in his home, neither did his post-separation payments.
The appellate court’s decision is no surprise and is consistent with the Moore/Marsden rule. According the the appellate court, Jodie had “confused” two separate legal concepts: 1) the Moore/Marsden rule, which creates an equitable interest when “community property is being invested in . . . separate property by creating equity in it”; and, 2) Watts charges, which can be assessed against a spouse who obtains a benefit from the use of community property after the date of separation, a rule enunciated in Marriage of Watts (1985) 171 Cal.App.3d 366. (“Watts charges,” although discretionary and in practice rarely awarded, are typically ordered as a reimbursement to the community where, for example, one party remains in the an entirely community property home after separation and therefore avoids rent which the community could have received had the home been rented during the post-separation period. Watts charges can apply to other types of community property as well.)
The appellate court then determined (for the first time in an appellate court in California, creating a legal precedent) that Watts charges “may be levied against a spouse for his or her post-separation occupation of a property where the property is not entirely community property due to the Moore/Marsden rule.” The appellate court rationalized its decision in this fashion: had Greg rented the home rather than lived in it for six years after the date of separation, the community could have been credited with a 33.6 percent share of the amount of the net rental profit after expenses. It should be no different when Greg lived there himself post-separation.
The appellate court then sent the case back to the trial court to determine the actual community beneficial interest (33.6 percent) and whether Watts charges should be assessed against Greg and in what amount.
This case interests me for several reasons. Jodie’s argument changed the law to her benefit, but not in the way she intended. The appellate court effectively ruled that Watts charges are now available whenever the community estate acquires any “constructive or beneficial equity interest” whatsoever as opposed to legal title. Jodie used a creative, although “confused” argument for separate property rental payments to increase the community beneficial interest in the appreciated value of the home. I assume Jodie would have been awarded an additional one-half of 33.6 percent of the net rental profit from the home during the six years prior to trial, along with one-half of the community share using the Moore/Marsden rule.
The appellate court quoted the language in Marriage of Moore: “Although the trial court designated the community’s interest as an ‘equitable charge on/right,’ it is clear under California law that the interest is properly characterized as a community property interest in the house. . . .”], meaning the community interest could be interpreted as not just a beneficial (reimbursement) interest but a legal one. The appellate court expressed it was not determining whether the community interest under the Moore/Marsden rule was just an equitable interest or a legal one, but then decided Greg may be required to reimburse the community estate – using the Moore/Marsden formula – for 33.6 percent of the net rental profit while Greg lived in the home for the six years after Greg and Jodie separated. (Remember, 33.6% represented the proportion of community funds used to pay down the mortgage principal to the total loan payoff amount, which was then used to determine the community share of the home’s appreciated value during the marriage to be reimbursed to the community estate. The Mohler appellate opinion now permits the community property percentage of appreciated value during marriage to be used in calculating a Watts charge. However, it does not permit what Jodie wanted, i.e., an additional percentage awarded to the community estate for the home’s increased appreciation after the date of separation.)
It seems that the appellate court determined the community interest is more than just an equitable one, one where post-separation rents under Watts must be apportioned under the Moore/Marsden rule between the owning spouse and the community but title remains in the owning spouse’s name. This ruling appears inconsistent with Family Code section 770 in that only the owning spouse of a separate property home is entitled to rents. Use of the Moore/Marsden rule should be limited to an equitable reimbursement interest where one spouse has always held legal title.
In a footnote, the appellate court wrote that, under Marriage of Nelson (2006) 139 Cal.App.4th 1546, an owning spouse cannot receive credit for the fair rental value of the home’s use while spouses live there together because, under the Moore/Marsden rule, the community is limited to compensation for the equity built on paying down the mortgage loan principal and not “credit expenses” incurred while living there. But with this appellate decision, when one spouse lives in his or her own home post-separation, the community estate can now receive credit for a portion of the net rental profit using the Moore/Marsden rule.
Imagine the unfairness to Greg of imposing Watts charges against him, awarding the community estate a percentage of the home’s net rental profits over the six-year period he lived in the home after separation. At least now, premarital couples are on notice that Mohler potentially invites Watts charges whenever a spouse brings a home with a mortgage loan into the marriage and the community estate pays down the loan principal.
*Some or all of the facts and analysis are paraphrased or my interpretation of this appellate opinion, and portions have been omitted or abbreviated. I did not participate nor did I represent any of the parties or witnesses in this case.