,ART[ C 7 marital planning for divorce, however, may actually ease some concerns associated : with dissolution of Real Estate and Divorce: marriage andremoveconflict.:from future marital de- cisionmakirg by initiating open communication re- 13m4ldht Up Is Hard To Do garding difficult topics Ownership; of. real: estate.I and sharing of expenses by Lauren J. Wolven, J.D. related to.real: estate isofteritroublesorne in new mar+ nages. andi. in divorce...Asciients marrying again, or later. hi life, .combin hOuseholds, issues regarding .: residential... an4 investment..p.opem es are brought to the forefront, an4.it: may, be useful to work the topic Ab5 tract ..... into th e .. analysis. of the client’s particular circum- stanceL Forexample, if a client mentions that heex- The divrc .e. rate has increased significantly over pectsto.:purchase:property,usc a discussion of expec- the last-few decade% and now almost half of all mar- tationsreg.rding that new, real estate as transition to a riages end ia divorce The majority of divorces in- discussion.of:divorce in .general. volve a divisiop of property, and many entangle real Yet anothermethod is t6 introduce the bare statis- estate ,.Vi second marriages, and more mar- tics. Switchiiig the focus to the general population and riages later in life, incorporating divorce planning into away: frn. the, clients can be.a useful method to break i areas, such as real estate, becomes even other pract’ce down the communicaon barrier regarding divorce more :rt:. when one considers the ancillary ef- Discussing past experiences, such as "I’ve dealt with fects of vorce a couple that had a similar issue is also helpful Disssingdivorce, particularly in the context of Many clients respond positively to having the attor- compietelyunre. lated transactions, can be tricky. First, ney break the ice and provide a forum to express con- this article a4dve sses.the ethical and emotional chal- . cerns the clients have kept silent. If a client reacts lenge that the .. attorney faces when representing. a negatively, you can simply move on, knowing you couple.Conteflp*W1 .g: marriage or the possibility of have tried and done your duty to the client by noting divorce, including.. a discussion of separate property the issue. Once the topic is on the table, counseling and a brieLint.odUcftry. guide to drafting premarital the client regarding some or all of the following in- agreements that..prot trea estate. Second, this article struments may be appropriate. explains :.w.... tiflCOi!pQ rate a discussion of divorce It is useful fdr attorneys dealing with real estate, as whenrepresentingcients.wbo are already married as set bwnershi.nUd tax issues to be versed in thetopic well as the use of postmarital agreements to protect of divorce. 8 article provides basic guidelines to . real estate. Third this article summarizes the proce- protect your client’s real estate in the event of divorce. dures involved in advising a couple (or spouse) con- Premarital Agreements templating divorce and the necessary follow-through Premarital agreements have become increasingly to protect real estate once a divorce decree is entered. popular in the last 20 years as a method to address the financial risks incident to divorce .4 Although premari- Advising Clients Contemplating tal agreements are useful in any, situation where the Marriage cost of preparation is appropriate in relation to the as- Raising the possibility of divorce with couples be- sets at risk, premarital agreements are especially help- fore divorce is even considered, preferably when a ful in certain situations. Some examples include couple is contemplating marriage, is important. There couples: (1) with disparate wealth, (2) one party to are reasons to believe that planning early for the pos- which does not work, (3) with disparate amounts of sibility of divorce is less stressful. When a relation- debt, (4) at least one party to which has children from ship is newer and a wedding is imminent, the "new- a previous marriage, (5) one party to which has been lywed phase" may lead to a more cooperative atti- through a contentious divorce, (6) one party to which owns an interest in a family business and (7) when tude.2 Early in a relationship, each spouse may be there is an anticipated inheritance. 5 Where there is an more willing to compromise and act reasonably, interest in a family home or real estate occupied by whereas, particularly if marital strife is the reason for one party that will become the marital residence, a a postmarital agreement, antagonism developed over premarital agreement is also an excellent tool to de- the course of the relationship may complicate concili- fine expectations and protect rights. ation. 3 No doubt, the topic of divorce is difficult to broach with clients who are contemplating marriage. Pre- ’ From 1978 to 1988, the number of premarital agreements tripled, and approximately 5% of marrying couples (50,000) sign premarital agreements each year. Marston, Allison A., "Planning Horwood Marcus & Berk, Chartered; Chicago, Illinois. for Love: The Politics of Prenuptial Agreements," 49 Stan. L Rev. ’Stake, Jeffrey E., "Mandatory Planning for Divorce," 45 887, 890 (1997). Vand. L Rev. 397, 419 (1992). See Haupt, Erika L., "For Better, For Worse, For Richer, For Poorer: Premarital Agreement Case Studies," 37 Real Prop. Prob. ’ id. & Tr J. 29, 29-43 (2002). Tax Management Real Estate Journal ' 2009 Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc. 203 ISSN 8755-0628 ARTICLES Couples who do not engage in the exercise of en- tentious divorces. 12 Many jurisdictions now authorize tering into a premarital agreement may not do so for couples to enter into these contractual agreements several reasons, from cultural taboo to emotional con- that, like business transactions, result from arm’s- cerns. It is important to explain to reluctant couples length negotiations where both partIes knowingly de- the benefits a premarital agreement may. provide both termine.their. rights in relation to one another. to the marriage and in the event of divorce.. The pre- MorØ than half thestates have adopted. the ijfrni marital agreement allows the couple to alter the de- Premarital Agreement Act (UPAA) in its entirety or fault statutory scheme with a divorce plan specific to with minor modifications.’ 3 Under the UPAA, a pre- their situation. Furthermore, the planning proces& re- marital agreement is presumed valid and enforceable. quired for a premarital agreement may benefit the A party seeking to void the agreement has the burden couple by communicating the expectations of each of proving that the agreement was unconscionable and party and exposing incompatibilities. 6 there was nondisclosure of property or financial obli- A premarital agreement also allows a husband and gations by one of the parties. Even without consider- wife to characterize their property as non-marital or ation, apremarital agreement is enforceable under the marital. In most jurisdictions, non-marital property is UPAA if it is signed by both parties. not part of the marital estate and is not divisible upon Although the UPAA has been adopted in the major- ity of states, a few states still leave the governance of divorce .7 The two most common forms of non-marital such agreements to common law. Although the re- property are (1) property acquired by gift, legacy, or quirements for a valid premarital agreement may vary descent before or during marriage, and (2) property across jurisdictions, three common criteria generally acquired before the marriage and not transferred into apply.’ First, the agreement must not be a product of co-ownership with a spouse. " Depending on your ju- fraud, duress, mistake, misrepresentation, or nondis- risdiction, income and appreciation from the non- closure of material fact. Second, the agreement must marital assets may or may not remain non-marital 9 not be unconscionable when executed. Third, changed Marital property typically is defined as all assets pos- circumstances must not make enforcement of the pre- sessed by either spouse during or on dissolution of marital agreement unfair or unreasonable. Generally, marriage.’0 the inquiry under the UPAA requires less disclosure The most effective premarital agreement is possible for a valid premarital agreement than does the com- only if the attorneys involved understand the law of mon law. 15 the governing jurisdiction regarding enforceability of Although courts typically focus on compliance with premarital agreements. The following introductory procedural requirements, they also analyze the pre- guide to preparing a premarital agreement serves also marital agreement for substantive fairness. There are as a general guideline for reviewing premarital agree- some limits on the types of provisions that a court will ments, but it is important to engage an expert (usually enforce. Generally, provisions that regulate day-to- an estate planner or matrimonial attorney) familiar day marriage issues, such as frequency of sexual, rela- with the particular requirements of the governing ju- tions or visits by the in-laws, are unenforceable. 16 risdiction to ensure effective planning that protects re- Some suggestions of provisions that a court would en- alty and other assets. 12 Id. Enforceability of Premarital ’ States that have adopted the UPAA in its entirety or with nil- Agreements nor modifications include Arizona, Arkansas, California, Con- Premarital agreements have a past history of hostile necticut, Delaware, District of Columbia, Florida, Hawaii, Idaho, treatment by the courts, which held that premarital Illinois, Indiana, Iowa, Kansas, Maine, Montana, Nebraska, Ne- agreements were against public policy because they vada, New Mexico, North Carolina, North Dakota, Oregon, supposedly fostered divorce." As the divorce rate in- Rhode Island, South Dakota, Texas, Utah, Virginia, and Wiscon- creased to its current level, courts and legislatures rec- sin. In 2009, it was introduced to Mississippi, Missouri, South ognized premarital agreements as more appealing Carolina and West Virginia. See also Uniform Premarital Agree- ment Act of 1983. than clogging the dockets with large numbers of con- 14 Schembri, note 11 above, at 333. ’ Id. at 335. 6 Marston, Allison A., "Planning for Love: The Politics of 16 provisions have also included (1) safekeeping Prenuptial Agreements," 49 Stan. L. Rev. 887, 890 (1997). of a treasured snowball collection in the freezer, (2) walking the Bennett, Margaret A., "The Real Estate Lawyer’s Divorce dog, or (3) authorizing a husband to sue for divorce if his wife gains more than 15 pounds. A court, when deciding on the en- Primer (and the Divorce Lawyer’s Guide to Real Estate)," 86 Ill, forceability of a provision that the husband’s mother could live B..!. 488, 489 (1998). with the married couple, stated that prospective spouses, in their 8 marriage enthusiasm, may make promises to one another outside 9 of human nature, and these promises violate public policy. Mar- " Jamieson, Lisa H., "Marital Property Issues in the Modern ston, Allison A., "Planning for Love: The Politics of Prenuptial Estate Plan," 49 Baylor L. Rev. 391, 393 (1997). Agreements," 49 Stan. L. Rev. 887, 900(1997), and Belcher, Den- 11 Schembri, Nancy R., "Prenuptial Agreements and the Sig- nis I., and Pomeroy, Laura 0., "A Practitioner’s Guide for Nego- nificance of Independent Counsel," 17 St. John’s J. Legal Comm. tiating, Drafting and Enforcing Premarital Agreements," 37 Real 313, 313 (2003). Prop. Prob. & Tr J. 1, 19. Tax Management Real Estate Journal 204 ' 2009 Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc. ISSN 8755-0628 ARTICLES force include the duration of the contraci, division of for either1 party to challenge the enforceability of the property, division of incorne.treaunent of debi,..speci- premarital. agreement. 24 fication of support and living expenses, decisions re- Even with separate representation,... the emotional garding surnames, birth control, children, housework, charge of premarital: agreements. can be surprisin domicile, reigion willsand inheritance, a plan for. the and. attorneys ’ should always proceed with ,caution. resolution of arguments, and dissolution of the mar- Many COflflflefltatOrs: opine that independent counsel riage.’7 is so important that it should be required for premari- Premarital agreements most often are attacked on tal agreements, even though imposing legal represen- the basis that there was duress, lack of knowledge re- tation may infringe on an individual’s freedom to con- gardIng the terms, overreaching, and unconscionabil- tract. 6 ity 18 A will-drafted and properly, e.. xecuted premarital Considerations for Drafting an Enforceable agreement, however, is likely to be upheld The effect Premarital Agreement of the emotional nature of the agreement generally is One of the most difficult challenges in drafting pre- not a defense, to enforcement’ 9 A threat to cÆliOffth marital agreements stems from the fact that it is virtu- marriage, even if the spouse is pregnant, will not of- ally impossible to envision all the possible directions ten constitute duress. Representation by counsel the couple may take in the future (children, careers, may preclude a claim of duress The statute of limita- inheritances, etc), as well as to contemplate the direc- tions on duress typically begins when the agreement tion the law may take when a spouse seeks to enforce is signed, and a claim of duress may be waived unless the agreement, possibly 15-20 years later. 27 Fre- timely asserted . 21 Furthermore, a refusal to read and quently, a party will attack the validity of the premari- endeavor to understand the agreement will not allow tal agreement alleging that the agreement is unfair avoidance of terms. 22 given the new set of circumstances at the time of the divorce. Although it is virtually impossible to fore- Ethical Considerations for Advising Clients close every avenue for challenge of a premarital Regarding Premarital Agreements agreement due to the uncontrollability of the future circumstances in which the couple may find itself, Representation during the signing of a premarital certain drafting techniques can reduce substantially agreement requires complete loyalty to the interests of the effectiveness of an attack on a premarital agree- a singLe party, whose interests more than likely are di- ment. rectly adverse to the interests of the future spouse Drafting in a manner that sets forth a separate pip. Rule 1.7 of the Model Code prohibits one attorney (or vision for every possible contingency creates inflexr firm) from representing a client with interests directly ibihty and ignores the unimaginable event The rec- adverse to another client. The rule also prohibits a ommended drafting approach, therefore, is to create lawyer from representing a client when the represen- an agreement that modifies itself over time by refer- tation would be materially limited by representation ence to external factors, either contingent or specific, of another client. in order to provide a flexible structure that will stand Even though Rule 1.7 does allow a client to con- the test of time In a situation where the growth po- sent to representation despite the conflict, separate tential of the assets of one party due to employment representation is strongly recommended .23 Represen- during the marriage causes the other party to have tation after consent may present ongoing risks of es- concerns that the agreement will not be fair after the calating the current conflict, placing the attorney in an ethical quandary, and possibly even opening the door 24 MRPC 1.7. See Schembri Nancy R Prenuptial Agree- ments and the Significance of Independent Counsel," 17 St. Johns 17 U. J. Comm. 313, 338 (2003). "Lack of independent counsel is not Marston, at 900 and Belcher and Pomeroy, at 19. fatal to a premarital agreement. The mere fact that a party was not 18 Horue Leonard 0., "Drafting Matrimonial Agreements represented is not enough, per se, to have a marital settlement - Pre-Nuptial Agreements," 300 PL/En 9, 30 (2001). agreement vacated or modified. The parties must have an oppor- ’9 1d. at 38. tunity to consult with an attorney; however, the lack of counsel in 20 1d. at 36-37. The attacking party may even be estopped from the formulation of a premarital agreement can be a factor or serve asserting the agreement is unenforceable. If the spouse acknowl- to corroborate a claim of fraud, deceit, duress, non-disclosure, co- edges the marriage would not have occurred but for the agree- ercion or overreaching." ment, the parties entered the marriage in reliance upon the agree- 25 Marston, Allison A., "Planning for Love: The Politics of ment. Prenuptial Agreements," 49 Stan. L. Rev. 887, 894 (1997). It is 21 Id. at 38-42. In some cases, a claim for duress can be waived also important to document the communication of the terms and even when the statute of limitations has not completely run. their meanings to your client, given the emotions that may be 22 Id. at 31-34. present. Also document issues intentionally not addressed by the 23 MRPC 1.7. First, the attorney must reasonably believe that agreement. With documentation, advice (or lack thereof) can be representing both clients would not adversely affect either client. demonstrated during an action for duress or a claim of malprac- In addition, both clients must consent after consultation. Under tice. 300 PUIJEst 9, 47. the revision of the Model Rules in 2000, the consent must be in 26 Marston, note 6 above, at 890, and Schembri, note 11 above, writing. Regardless of whether a writing is required by a particu- at 338. 27 lar jurisdiction, it is always recommended, Florescue, note 18 above, at 18. Tax Management Real Estate Journal ' 2009 Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc. 205 ISSN 8755-0628 passage of substantial time, one solution to address a party’s separate property under the laws of the gov- this concern is to have the agreement extinguish itself erning, jurisdiction, clients need to be protected iroiii entirely or in part, contingent on certain events, gen- inadvertent commingling with marital property or erally the passage of time. conversion to community property. This is particu- For example, Mary is a successful physician with larly difficult with the primary residence, when huih two children from a prior marriage. Her spouse, Jack, parties may contribute their salaries to mortgage pay- is a successful sales manager who agrees to stay home merits on the home owned by one party before the and care for the children of Mary because Mary’s in- rnarnage.. come is 10 times the income of Jack. Jack W. con- With regard to growth of premarital assets, it is im- cerned that if the parties are married for a length of portant to address whether appreciation and income time, say 15 years, and then decide to divorce, Jack from those assets will be treated as marital property will be in a situation where he has given up a. career or as separate property. Failure to clearly identify and to enable Mary to further her career, and Jack feels address premarital assets in the premarital agreement equally entitled to share in the financial benefits of can leave the client to face the often impossible task that joint endeavor. This type of situation is one where of tracing the assets back to premarital property when it may be appropriate to terminate the property divi- the parties later divorce, which may be many years sion provisions of the premarital agreement and leave later. Including a definition of separate property is im- the decision to the courts or agreement of the parties portant, as is ensuring the definition is clear and con- in the event of divorce. sistent with the parties’ intent regarding division of as- As noted earlier, one of the most important techni- sets upon either death or divorce. One useful tech- cal requirements is ensuring lull and complete finan- nique is to attach to the premarital agreement a cial disclosure to ensure an educated understanding of separate schedule of each party’s separate property, the agreement (aided by counsel). 28 The more detailed which at least provides a starting point if tracing does the information, the better the disclosure protects the become necessary. In certain situations, it may even disclosing party. In addition, the information should he advisable for clients to file separate tax returns fol- he updated to ensure that it is as accurate as possible lowing the marriage to continue reinforcing the sepa- 32 at the time the premarital agreement is signed. If par- rate property designations. ticularly valuable real estate is involved, an appraisal For real estate, it is important to address existing may be advisable. As evidence of disclosure, it is rec- equity, future contributions to reduce indebtedness, ommended that a net worth statement he attached to and appreciation. Use and ownership upon separation the agreement itself. The client should be advised that and divorce are important to consider, as is treatment the disclosure is a legal requirement, which may en- of capital contributions for major renovation or even Disclosure often prompts addi- routine repairs and maintenance. To ensure that the tional negotiations, so provide the financial statement co premarital agreement is effective upon death as well on a schedule that gives the other party ample time to as in the event of divorce, it must contain a general of review and respond. waiver of the spouse’s state law rights as against the 33 Disclosure is essential, as courts often view disclo- estate of the deceased spouse. The waiver may be a sure as the equivalent of fairness. 29 If the client has general waiver or a specific waiver as to a certain cat- concerns about leaving the disclosure documentation egory of property, such as separate property (as de- in the hands of other individuals, arrange to have all fined in the premarital agreement). 34 copies returned and provide in the agreement that the One way to maintain flexibility of the document information will be produced only in the event of liti- and to maintain a level of fairness is to increase the gation between the parties regarding the remarital surviving spouse’s share of the decedent’s estate over agreement and only under protective order. time. Another option is to terminate the waiver after Difficulties of ensuring proper disclosure and con- the parties have been married a certain number of cerns regarding fairness aside, the most frequent prob- years, thereby leaving the spouse full rights to de- lem areas in drafting arise in defining premarital prop- mand a spousal forced share. Because the spousal city and income, and in resolving estate rights, dispo- forced share may be defeated by the establishment of sition of the marital residence, spousal support, and a trust under the law of some states ’ 35 it may be pref- bequests in conflict with the agreement. 3 Property erable to define the rights under the agreement rather owned before the marriage should be addressed than reverting to state estate rights. In any event, de- clearly in the premarital agreement. Although prop- fining what assets are included in the estate is impor- erty acquired before the marriage may be considered 32 Schlissel, note 29 above. 28 1d. at 43-44. It is important to take this disclosure seriously. 331t is important also to consider limitations on a surviving Although it is commonly expected that spouses have duties to spouse acting as administrator or executor or serving in some each other, many jurisdictions also hold that a fiancØ has a fidu- other fiduciary capacity in the estate. ciary obligation to a future spouse. Florescue, note 18 above, at 9. 29 Schlissel, Stephen W., "Negotiation and Drafting Consider- See, e.g., Johnson v. LaGrange State Bank, 383 N.E.2d 185, ations," 184 PLI/Est 51(1989). 192 (Ill. 1978); Johnson v. Farmers & Merchants Bank, 379 Id. S.E.2d 752, 756-757 (W.Va. 1989); In re Estate of Wechsler, 225 Florescue, note 18 above, at 9. A.2d 785, 786 (N.Y. App. Div. 1996). Tax Management Real Estate Journal 206 ' 2009 Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc. ISSN 8755-0628 ARTICLES tantt as is requiring that the parties be living together relinquishment of property rights was a taxable gift. 42 (as well as married) at the time of death in , order for Additionally, a prospective. spouse cannot give up his ther survivor to receive any share of the estate. orproperty rights in exchange - for marriage. Particularly with second inamages or later-in-life Supreme Court fod that although marriage may be marriages a couple may reside in a home previously &qi ate: consideration l undet;: contract law, it could owned by one spouse. If the spouse with title to the not be reduced to monetary value. However, if pro- house dies first it is important to consider a living ar- spective: exchan ge mutual releases of future rangement for the surviving spouse and who will be marital rights, there are no tax implications. 45 responsible for the payment of mortgages, taxes, and upkeep. Provisions for sale of the home upon the sur- Keeping Separate Property Separate vivor wanting or needing to move (e.g., into a nursing home)1 should becoæsidered; Whatever the case, the Whether or not a:. couple signs a premarital agree- provisions of the premarital agreement should be in- is important to educate clients on the law re- Ifleflti:it corporated- intO the client’a estate plan so that the two garding marriage, and property in their state. Even are, or ambiguous, which would open without a premarital agreement, it is possible to keep the door . e:.litj.gatjofl : separate.. "property: in the hands of the person who Consistent withi the goal Of avoiding protracted liii- brought it to the marriage upon divorce. Particularly gatioiflover property, a premarital agreement custom- with real estate, where use of joint funds to pay a re- arilyincIudes a: provision that neither party will con- lated debt can so easily blur the lines, it is important testtheother’s will 37 In light of this clause, can a be- to advise clients regarding the conversion of premari- quest to a spouse in the will amend a premarital tal or separate property into marital or community agreement withłut a written modification of the property, and the consequences. agreement and consent of both parties? To avoid un- Tracing separate property over the course of a mar- intŁntiOnal Inodification of the premarital agreement and to forecloSe thØ argument that the premarital riage can be problematic. If clients decide to forego a agceerriertwas nullified by a party’s actions in prepa- premarital agreement, they should be advised of the ration of the party’s estate plan, the premarital agree- importance of maintaining separate records and the meæt shOuld a statement that the waiver of implication of using marital funds to pay a debt obli- spousel rights doe.S not preclude a party from actually gation on real property. Clients should be advised not bequeathing more than is required under the agree- to add funds to premarital bank or investment ac- ment, and neither does the waiver preclude the survi- counts in order to prevent commingling. Furthermore, vor from accepting such a bequest it is recommended that the clients open new bank and investment accounts to receive and use all income Tax Implications earned during the marriage by the couple for their The typical premarital agreement involves payment "marital" financial activities. by one spouse in exchange for the relinquishment by Even if the parties do not want to create a premari- the other of property (courtesy, dower, or survivor- tal agreement, they may wish to have a less formal ship) rights. 3 Section 25 12(b) of the Code dictates letter of agreement regarding joint contributions to that when pr operty is transferred for less than ad- real estate that was purchased with separate assets. equate and full consideration in money or money’s Having such an agreement may make life easier by re- worth, the amount by which the value of the property quiring less diligence in maintaining separation of exceeds the value of any consideration given is a property. The Code is clear that the relinquishment of property rights does not satisfy the requirement for States are divided on whether property (real or per- adequate and full consideration. 40 Many couples try sonal) acquired before marriage is susceptible to divi- to get around this by drafting a premarital agreement sion upon divorce.’ The maj7ority of states statutorily in which one spouse gives up his or her common law exempt premarital property. 4 However, there are two or statutory forced share of the other spouse’s estate conditions that will cause exempt premarital property or they include a provision stating that community to become divisible marital property; the "use" test property laws will not apply if there is a dissolution and inseparable commingling. 48 Under the "use" test, of marriage. 4’ Unfortunately for estate and gift tax premarital property becomes marital property if used purposes, the Supreme Court in Merrill v. Fahs held for the common benefit of both parties during the that the relinquishment of property rights was inad- equate, and the transfer of funds in exchange for the 42 Merrill v. Fahs, 324 U.S. 308, 312-13 (1945). O’Connell, note 38 above, at 25. Florescue, note 18 above, at 9. Comr v. Wemyss, 324 U.S. 303, 307 (1945). Id. O’Connell, note 38 above, at 26. O’Connell, Marjorie A., Estate Planning for Divorced or Re- 46 Diehl, Michael, "The Trust in Marital Law: Divisibility of a married Individuals, CA39 ALl-ABA 1, 24 (Sept. 7, 1995). Beneficiary Spouse’s Interests on Divorce," 64 Tex. L. Rev. 1301, §2512(b). 1338 (1986), 4 O’Connell, note 38 above. Id. 41 48 Id. Id. Tax Management Real Estate Journal ' 2009 Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc. 207 ISSN 8755-0628 marriage. 49 Commingling occurs when one category property, but three of the most common are self- of property is. mingled with another in a fund or asset, settled, revocable, and irrevocable trusts. such as using both premarital and marital funds to .\ self-settled trust enables a beneficiary to contrib- purchase a home Residential real estate is particu- ute his own assets to a discretionary irrevocable trust larly susceptible to falling prey to a divorce under and protect the trust income and principal from being both tests. marital property, as long as he does not have the right Additionally, there is the problem of income and in- to withdraw the trust assets. 55 .\ revocable trust, creased value that accrues: from premarital property; is which may be altered at any tulle, is considered part it premarital or marital? 51 There tend to be three rules of the grantor’s estate, accessible by creditors and of law, which are hihlighted..by California, ColOradO, spousal claims, and subject to taxation. The irrevo- and Texas. California considers both income and in- cable trust (the 11(1st that offers the most protection) creased value to remain premarital: property, Colorado requires the grantor to give up all property rights over regards the increased value as marital property, and the trust corpus, which effectively removes the corpus Texas treats the increased value as premarital property from the grantor’s taxable estate and prohibits spousal and the income as marital property. 52 Among the claims against it. However, the beneficiary with a states that recognize a difference between premarital mandatory interest should consider holding any in- and marital property, the majority follow the rule of in me come distributed to him in a separate account with no other assets to avoid commingling the distributed in- law in Texas? 3 In some states, it may be easy for a conic with premarital property, in the event it is deter - real estate investor to immediately and unknowingly mined that such distributed income was marital prop- offer up his investment growth to his spouse through the act of marriage. erty. .J urisdictiotis that do not grant special treatment for property classification consider all trust distributions Advising Married Clients divisible at divorce; U . premarital property is cx- Discussing divorce with married clients is no easier etilL. a corpus distribution may he divisible."’ In ju- than broaching the topic with couples contemplating risdictions that exempt only premarital and inherited marriage. Even though the, couple is already married, property, an inter vivmis gilt can he divided. -59 Further. planning for divorce may initiate important open com- F state law prohibits the distribution of premarital munication regarding difficult topics. In fact, they property and property acquired by gift or inheritance, may be more honest: (which can be good or bad) than the trust corpus should also he exempt from distribu- couples contemplating marriage. tion even though the increased value and income ma Married clients, should be advised of the state law be divisible.’"’ Finally, the ability to access and use regarding property rights upon divorce and death as trust corpus is equivalent to constructive possession; part of the planning conversation. Surprisingly, mar- once the beneficiary takes possession ot the trust ried clients often react positively and have thoughtful through a required distribution, the trust no longer cx discussions regarding divorce, and those conversa- &n ists and the property is subject to’...sion!’’ tions aid in the planning process. Clearly, however, Enforceability of I’osimariial .-lgreements not all clients will appreciate the mention of divorce, Courts have been even slower to accept postmarital and it is important to weigh the benefit of such a dis- agreements than premarital agreements. largely due to cussion against antagonizing a client. the issue of consideration. Courts enforcing postman- If, during the course of planning discussions, cli- tal agreements conclude that the waiver of statutory ents reveal that they have commingled separate prop- , rights created by marriage constitutes consideration erty unintentionally, and both spouses desire to rem- for the agreement.’’ No jurisdiction will support a edy the situation, a postmarital agreement may be ap- posttnanital agreement where a spouse agrees to do propriate. Postmarital agreements also may be what he or she is already obligated to do by law" warranted following a reconciliation of estranged The trend in the law, however, is toward upholding spouses or when a couple later decides to have a child these contracts when there is adequate consideration. and one of the spouses has a child by a prior marriage In jurisdictions that enforce postmarital agree- Continuing to Keep Separate Property Separate ments, the criteria generally are the same as the erite- In most states, premarital property that is carefully designated as inaccessible trust corpus will remain separate property along with 54 appreciation of the the Herman, Keith A., "How to Protect Trust Assets from a Ben- trust at the time of marriage. Several different types eficiary Divorce," 63 J. Mo, B. 228, 233 (2007). 56 of trusts exist that can be used to protect premarital Id. ’ Diehl, note 46 above, at 1346. 58 Id. 40 Id. 59 1d. Id. 60 1d. s’ Diehl, note 46 above, at 1341. ’ Id. 62 K’an, Ronald S., "Tax Aspects of Spousal Rights: Pre 52 Id. 53 1d. at 1338. and Post Mortem," 184 PLtIEst 301, 303 (1989). 63 Id. at 1346. Id. Tax Management Real Estate Journal 208 ' 2009 Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc. ISSN 8755-0628 ARTICLES na for enforcing premarital agreements. 64 Full finan ianships and trusts, for children. No steps should be cial disclosure is probably the most nporta. factor taken: to transfer assets. (such: as.ititling real estate) to determine fairness Once again ,.a court will review without the approval of the divorce attorney; Overly an agreement for procedural and substantive fairness aggressive action .. regaling’::.asset.. transfers or estate The typ1al attacks on postmaritalagreements ate the planning may, prejudice .the:clienVs case and do more same as those with respect to premarital agreements. harm than good in the end. However4 post marital agreements are often challenged Encourage divorcing:..’:dlients to review and update for lack of consideration. their estat&.’plans. ’ The’. fiht step is reviewing asset . : Ethical Considerations for Advising Clients ownership and dt eennuung whether the plan com- Regarding PsttoiAgiemts ports with the requirements of any premarital or post- marital agreement. An estate plan contradictory to the As with. premarital agreements, ttorny representa terms of an i agreement could result in protracted estate tion during the signing, of a postmarital agreement litigation if the client dies while the divorce is pend- protects the interests of a client with interests directly ing Estate litigation will spend down the assets avail- and openly adverse to those of the other. spouse Rule able to other legatees on attorney fees, expenses, and 1.7 of the Model Code prohibits representing both court costs arid’ . rnay prevent other legatees from re- spouses, and even though Rule 1.7 does allow a client ceiving any benefits from the estate for several years. to consent to representation despite the confhct, sepa- Advise the client to gather evidence as to the char- rate representation is virtually required and is strongly acter of property. For example, the client may have recommended The ongoing risks of the conflict are documents that enable him or her to trace shares of even more intense with postmantal agreements due to stock to a gift or inheritance, which would make the the higher threshold for court enforcement shares ’separate property. Or, the client may have a pa- Drafting a Postmarital Agreement per trail documenting a down payment on real prop- Again, issues that arise when drafting a postmarital erty that came from separate assets. Funding sched- agreement generally are the same as the issues that ules on trust agreements also can be useful. Property arise when drafting a premarital agreement, SIdet- that is traceable as separate property is not subject to ing both can serve the same purposeL The only -:issue division or transfer by the divorce decree. For this that should be conten plated more SC! with a . us reason, clients who have been receiving annual gifts postmarital agreement i§ the consideration. for en- from family members should either request that the forceability. If the parties are negotiatg . pifica11y gifts cease until the divorce is final or that the donor to address issues with real estate, it may be possible establish a separate trust to receive those gifts while to use exchange of rights related to the property to the divorce action is pending Separate assets can be create consideration. transferred or otherwise dissipated in theory, but in Postmarital agreements generally are perceived as practice it is best to have the client consult with the stemming from conflict, and therefore, are thought of matrimonial attorney before any asset transfers are as more difficult to prepare. Often, however, postniari- made tal agreements are easier to draft because the couple Married couples often designate their spouse as the is more likely to have one or a few specific issues that beneficiary of life insurance, retirement plans or other bring them to the table. In addition, depending on the property that passes by beneficiary designation Al- length of the marriage so far, it may be easier to nar- though the soon-to-be former spouse’s signature may row future contingencies that need to be addressed in be required to change certain beneficiary designations, the agreement. For instance, the couple may already e.g., 401(k) accounts, beneficiary designations should have children, own a home together, etc. Those issues be changed if appropriate and if the matrimonial at- can be addressed directly and perhaps more concisely torney is in agreement. In addition, a revocable trust than they would be in a premarital agreement. may be desirable to help avoid the spousal forced share rights under state law in the event the client dies Advising Clients Contemplating before the divorce is final. In many states, as long as the assets pass through a nonprobate environment Divorce (e.g. joint ownership, beneficiary designations, totten A divorcing spouse’s first call should be to his or trusts, and revocable or irrevocable trusts) they are not her matrimonial attorney. The second call should be to subject to the spousal elective share. 67 his or her estate planning attorney. An existing estate The Use of Trusts to Protect Property plan may need revision, and a client without an estate A trust is one of the most practical ways to prevent plan must assess the need for one given laws regard- loss of real property and is often employed by one ing intestate share, spousal forced share rights, guard- 67 Baskies, Jeffery A., "Family Law: Step Two in Any Divorce 64 1d. 65 id. Proceeding: See an Estate Planning Attorney," 72 Fla. Bar. J. 80, 66 See, e.g., Johnson p. LaGrange State Bank, 383 N.E.2d 185, 192 MRPC 1.7. First, the attorney must reasonably believe that (Ill. 1978); Johnson v. Farmers & Merchants Bank, 379 S.E.2d representing both clients would not adversely affect either client. 752, 756-757 (W.Va. 1989); In re Estate of Wechsler, 225 A.2d In addition, both clients must consent after consultation. 785, 786 (N.Y. App. Div. 1996). Tax Management Real Estate Journal 2009 Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc. 209 ISSN 8755-0628 EIE spouse o protect his or her property from spousal Premarital Agreement claims.6 The trust can be created through premarital If Betty and her fiancØ execute a premarital agreement, while considering or in the process of a di- vorce, or through a postmarital agreement. Although agreement valid under the laws of Betty’s trusts are quite common care must be taken to avoid state of residence at the time of her marriage, an unintentional taxable gift upon creation of the trust and the agreement addresses the treatment of Jack and Mary live in a state that excludes revo- her separate property and the division of cable trusts from spousal forced share. rights. Prior to marital property upon divorce, then the marryMg. Mary, Jack. transferred assets to a trust un- trustee shall distribute $40,000 to Betty on or der the. terms that he retained the rights to the trust in- before the date the wedding is solemnized. come as. well as general power of appointment. Through. a specific waiver, Mary waived her right to Incentive provisions must be used with thought and Jack’s estate, to. the. extent she would receive trust as- sets,, but is able to take her marital share from the re- skill, however, because they truly may represent "bad mainder of Jack’s estate outside the trust. Because psychology." If they are viewed as trying to control Jack did not transfer any property to Mary there are the child’s life choices, incentive provisions may be no tax implications. more likely to produce rebellion than compliance Trusts to Protect Younger Generations Incentive provisions also can be risky because if crafted in a manner that is too restrictive or inequi- More and more couples are looking to prevent the table, they can be a source of litigation. Provisions loss of their beneficiary’s property because of divorce. that encourage divorce or are otherwise contrary to For example, if Jack and Mary create a testamentary public policy will be voided, and any trust restriction or inter vivos trust for their children or descendants, touching on premarital agreements skirts close to the these trusts can protect the trust assets against the ben- line. The trick in using such provisions is to get .the eficiary’s spouse in divorce proceedings. 69 If Jack and message across to the beneficiary without creating Mary’s beneficiary has no more than an expectation such inflexible rules that the beneficiary becomes bit- that he will receive the trust corpus or income, then ter or frustrated. he does not have the power to demand distribution of Another challenge with requiring a beneficiary to the trust corpus or income. 70 Until trust corpus or in- have a premarital agreement is that the agreement has come distribution is required, it remains trust property value only if the particular state of residency recog- and is neither premarital nor marital property. 7 If a beneficiary receives regular distributions, however, nizes the premarital agreement. 74 Fortunately, as indi- some courts will consider that income for property cated above, a majority of the states recognize and au- settlement and support purposes. thorize premarital agreements . 75 The greater issue to To protect the premarital property of a trust, it may consider is whether the beneficiary will raise the ar- be advisable to include provisions to prevent the dis- gument that he or she was forced to sign the premari- tribution of property during divorce. 72 Specifying tal agreement under duress, (e.g., there was a threat to state law for trust administration and distribution is an cease distributions if the agreement was not signed). 76 added layer of protection for real property. An attor- Finally, it may be useful to include a statement of ney could include a clause from a more divorce- the grantor’s intent with the trust instrument. 77 Al- friendly jurisdiction stating that "the property inter- though courts tend to frown on trust statementsthat ests of the beneficiary shall be determined by the law mandate ’income from the trust shall be the benefi- of the chosen forum." 73 Whether a divorce court will ciary’s separate property" because it is contrary to the honor this clause is debatable, but it does not hurt to public policy argument that the former spouse should include it. Careful contemplation of the governing be provided for, a grantor might get lucky and wind law, the beneficiary’s rights, choice of trustee, and the up in a state that permits grantor intent to sway the definition of "spouse" are important in drafting a trust general equitable powers of the court. 78 that will be effective in a divorce situation. Although steps can be taken to protect real property In the past decade, incentive trusts have been a hot from divorce, problems still exist when the property topic, and some grantors will use this type of trust to is left by gift, bequest, devise, or descent, which is require their beneficiaries to have a premarital agree- why the creation of trust with very specific directions ment in order to continue to receive distributions. is so important. If assets are left to a beneficiary out- These trusts provisions are specifically targeted at en- right, the property received by the beneficiary will be couraging or discouraging particular behaviors. For protected from a marital property division. Depending example: on the jurisdiction, however, a spouse may argue the income and appreciation from the assets is marital 68 O’Connell, note 38 above, at 26. 69 Jamieson, Lisa H., "Marital Property Issues in the Modern Id. at 1357. Estate Plan," 49 Baylor L. Rev. 391, 399 (1997). Id. ’ Id. 76 Id. at 1356. 71 Id. 77 1d. at 1358. 72 Diehl, note 46 above, at 1355. 78 Id. at 1359. 73 1d. at 1356. Tax Management Real Estate Journal 210 ' 2009 Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc. ISSN 8755-0628 ARTICLES property." If Mary created a revocable trust that instead find evidence of actual ownership alo with stated all assets were to be distributed to her children any encumbrances on the title 0 the property. A in equal shares, each child would receive $100,000 tionally, a vengeful spouse can use a pre-existing line that would be considered the child’s separate property. of credit or ahome equity loan to obtain large Tf the child purchased a home with.. $100,000 and amounts of money without the knowledge of the the child’s spouse refurbished the house to resell it, ’then. 85 Take care to obtain written documentation the appreciation in the value of the home might be from the mortgagors, lenders, and banks that the line considered marital property because of the labor con- of credit has been closed. 86 tributii the spouse made to the appreciation of the Employing..strategies to cut off a vengeful spouse home. must be done with care in order to avoid antagonizing tCesiding over Anotherproblem with leaving property outright is thejud that that separate ?roPerty is often commingled with man - erishin ge spouse with the financial disadvantage. property. 8 So, if Mary’s child took the $100j1O() Asset transfers considered to he fraudulent convey- tell tO herin a revocable trust and put it into a broker- ances will be set aside, SC) caution is i’equircd. 5 ’ Also, age account that contained money earned during the it may be strategic to demonstrate good will and the marriage, the $100,000 is now commingled property and ptentiaJly subject to division upon divorce. Al- desire to preserve assets for the parties and their chil- dren. One effective technique is to establish a separate though cuiiuninglin property does not always result in marital property. if there is no way to determine the trust to hold for safekeeping assets pulled from joint nrn-mantal share, there is a statutory presumption accounts. that all property acquired during marriage is marital. 1’ Additionally, if a spouse puts non-marital property in the names of both spouses, the properly may he con- Conclusion erted into marital property. 83 Regardless of whether or not planning was done To avoid any commingling of property or inadvert- while the divorce was pending, an estate plan review ent conversion of separate property to marital, atlor- that incorporates an analysis of asset ownership and neys should advise heir clients to think about trails- beneficiary designations is necessary once the divorce furring property to family niembers in a discretionary decree i is final. Even seemingly minor last-minute lifetime trust. If property is held in trust, then it can- changes to a settlement agreement may create a con- not be thoughtlessly titled in joint name or com- flict with the estate plan, disrupting the intentions of mingled with marital property (as lung as the spouse the testator and opening the door to estate litigation if does not contribute his ov,-ii assets to the trust). the not resolved during the client’s lifetime. sidered principal of the trust should not he considered ii ian tal Attorneys can do great service to their clients by property I I I as tong as the beneficiary has no property advising them regarding divorce and the protection of right in the principal of the trust, and (2) the trust con- real property no matter their marital status. Ignoring tains a spendthrift clause. If the beneficiary has the the contingency of divorce, which is the result of ap- right to withdraw assets from the trust, however, the proximately 50% of all marriages, leaves planning in- corpus may he open to attack on divorce. complete. Knowing the law regarding separate prop- One problem clients often face in divorce is the erty, premarital agreements, and postmarital agree- vengeful spouse. A discussion w ith the matrimonial ments is crucial to effective planning and to attorney regarding legal descriptions of property. representing the best interests of clients. freezing lines of credit, and severing joint tenancies is important. The careful attorney will not settle for the legal description of a piece of real property, but will 84 Bennett, Margaret A., "The Real Estate Lawyer’s Divorce Primer (and the Divorce Lawyer’s Guide to Real Estate)," 86 III. 79 Herman, note 55 above, at 229. B..!. 488, 490 (1998). 80 85 Id. Id. 81 86 Id. Id. 82 Id. Zolla, Marshall S., "An Interdisciplinary Approach to Mod- 87 83 Id. em Family Law Practice," 23 L.A. Law. 19 (2000). Tax Management Real Estate Journal ' 2009 Tax Management inc., a subsidiary of The Bureau of National Affairs, Inc. 211 ISSN 8755-0628
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