Equitable Distribution of Property in Virginia: What is “Hybrid” Property, and How is it Divided?
Do the words “Brandenburg,” “Keeling,” or “reasonable rate of return,” mean anything to you? Probably not — but if you’re going through a divorce, they had better mean something to your attorney! Each is a different method that has been used by Virginia courts to divide hybrid property between spouses.
First of all, what is property?
“Property” is a general term that includes everything of value owned by two married people. It can include real estate, bank and investment accounts, retirement accounts, pensions, stock options – even “intangible property,” like the right to profit from patents or books written by a party.
Ok, so what is hybrid property?
In a Virginia divorce case, property owned by either party, or both parties together, can be classified by a court in one of three ways: marital, separate, or a combination of the two, known as “hybrid.” Marital property is generally any property acquired during the marriage, by either party individually or by both parties together, regardless of how the property is titled. Separate property is generally any property acquired by a party before the marriage; acquired during the marriage if by gift from a third party, inheritance, or other source outside the marriage; or acquired after separation.
Hybrid property is a combination of marital and separate property. It can occur in many forms, for example:
- Wife uses pre-marital funds to make the down payment on a marital house that appreciates in value during the marriage;
- Husband has $50,000 in a 401(k) fund when he gets married, but adds $30,000 to it over the course of the marriage;
- Wife receives an inheritance during the marriage and adds it to a parties’ existing investment account;
How does one determine the parties’ percentage interests in hybrid property?
In Virginia, there is no set formula for determining parties’ percentage interests in hybrid property. However, courts have used at least three different methods for dealing with this issue – the “Brandenburg” formula, the “Keeling” formula, and “reasonable rate of return.”
The Brandenburg Formula
The Brandenburg formula is named after the parties’ names in (of all things) a Kentucky divorce case from 1981. The formula somehow caught on in Virginia and other states, and for several years was the only formula that had been approved to determine the parties’ interests in hybrid property by the Virginia Court of Appeals. The formula looks like this:
————————- x Total Equity = Separate interest
————————- x Total Equity = Marital interest
In practice, it works like this: Joe and Sally get married and buy a house for $200,000. Joe uses $20,000 of his separate money for the down payment, and they take out a mortgage of $180,000 to cover the rest of the purchase price. They divorce ten years later. At that time, the house is worth $500,000, and they have reduced the outstanding mortgage by $50,000 to $130,000. Applying Brandenburg, Joe’s separate interest would be $20,000/$70,000 x $370,000, or $105,714. The marital interest would be $50,000/$70,000 x $370,000, or $264,286. If the marital interest were divided evenly (as is usually the case), Joe would receive a total of $237,857, and Sally would receive a total of $132,143.
Brandenburg is probably the most common way of dividing hybrid property, and it is used almost exclusively in determining the marital shares of financial accounts such as IRAs, 401(k)s, and other similar accounts.
However it is not necessarily the fairest method in all cases, especially in cases of real estate that is encumbered by one or more mortgages. This is because Brandenburg does not take into consideration any payments made towards carrying costs like mortgage interest, real estate taxes, or other costs. It only considers down payments and reductions to the principal of a mortgage. Consider, for example, a hypothetical case in which a wife places a mere $3,000 of her separate property down on the purchase of a $300,000 home (not an entirely uncommon scenario before the real estate bubble burst). The remaining $297,000 was paid for by an interest-only loan. The husband made all the mortgage payments from his income, but, because the loan was interest-only, never reduced the principal. Three years later, the home is worth $500,000, and is still encumbered by a $297,000 mortgage. A strict application of Brandenburg would mean that the entire $203,000 in equity was the separate property of the wife, based on only her $3,000 initial investment!
The Keeling Formula
The Keeling formula is named for the case of Keeling v. Keeling, 47 Va. App. 484 (2006), where it first appeared in a published Virginia case. In Keeling, the parties purchased a home for $394,000, which had appreciated in value to $825,000 at the time of trial. The husband made the down payment on the purchase from his separate funds in the amount of $108,439, and the parties paid the mortgage down only a very small amount during the marriage. Strict application of the Brandenburg formula would have classified 96% of the house as the husband’s separate property. The trial judge declined to use Brandenburg, because he determined it would be inequitable to the wife. Instead, the trial judge determined that because the husband’s down payment of $108,439 was 27.5% of the original purchase price, that the husband’s separate property would be 27.5% of the home’s value, or $141,885, and the remainder of the equity would be marital.
Reasonable Rate of Return
To determine one’s separate interest in hybrid property via reasonable rate of return, one simply applies a rate of return to a party’s separate investment in an asset. As of this writing, the reasonable rate of return method has not appeared in any published Virginia opinions, but has appeared in at least one Circuit Court decision. See Thomas v. Wiese, CH2003-185175 (Fairfax Cir. Ct., McWeeney, J.). Reasonable rate of return is the most flexible way to determine a parties’ separate interest in an asset. This is because the “rate” to be used can be virtually any rate one can think up. The idea behind this method is to give the party back their initial investment, plus some appreciation for the missed opportunity to invest those funds elsewhere. The rate of return can be based on almost anything, from the relatively low interest rate on 10, 20, or 30 year Treasury notes, to the return on the some measure of stock market performance, to a rate based on the appreciation of the asset itself
The various ways to determine percentage interests in hybrid property really only scratch the surface of the myriad issues that accompany dealing with such property. Many additional issues can arise. To name a few: 1) determining the parties’ interests in a piece of hybrid real property when a so-called “cash-out refinance” of the mortgage is performed, or a home equity line of credit is taken out and drawn on; 2) determining the parties’ interests in a bank account existing before the marriage when various transactions have occurred over the course of a marriage; and 3) determining the legal effect of re-titling property held solely by one party before the marriage into joint property during the marriage.