General Principles: Businesses Can Be Community Property
The property division process is always made more complicated by the inclusion of a business. Things can become quite a bit more complicated when the business increases in value during the marriage, or when the value of the business fluctuates widely. But, even when the business itself is relatively simple, including a business in a divorce invariably makes things trickier.
There are some key things to know when it comes to understanding how assets held by a business are handled in a divorce. One of the first things to know is that a business entity itself will have a classification as either marital or community property, or separate property. And, in general, this classification follows the standard principles which apply to other assets. This means that a business created prior to marriage will generally be separate property, and a business created after will generally be community property.
Classifying Assets Held by Business Entities
When a business entity holds substantial assets of its own – i.e. inventory, cash reserves and other receivables, real estate, etc. – parties to a divorce naturally wonder: how will these assets be classified for property division purposes? The answer is that assets held by business entities are generally classified according to the classification of the business entity itself. In other words, in general, assets held by business entities will not have their “own” classification, but instead will simply follow the classification of the underlying entity. Hence, if a person enters a marriage with a preestablished business as his or her separate property, then the assets held by that entity will also have this same classification. This is true at least for those assets held by the entity when the marriage commences, as increases in a business’s value during marriage are generally treated as community property.
To some readers, this clarification may seem relatively unimportant, but it can have significant implications when it comes to actually dividing up assets in a Colorado divorce. Since separate property business assets are the sole property of the owner, the division process is simplified because spouses won’t be quibbling over separate property.
The Issue of Increases in Value during Marriage
As mentioned, whenever a business sees an increase in its value during the marriage, this increase in value is typically categorized as community property. This is true even if the business entity (and, by extension, its assets) itself is classified as separate property. In certain instances, therefore, a business’s value can literally be “mixed” in its classification, as it can be both partially separate property and partially community property. Consider the following scenario: a spouse enters a marriage with a business – in this case, let’s suppose a dental practice – and the business is valued at roughly $1,000,000 when the marriage begins. Then, by dint of hard work and market fluctuations, the business increases in value during the marriage, and then by the end of the marriage the business is valued at $1,500,000. During the property division phase, the increase in value of $500,000 is actually “community property” and subject to division. Of course, when a business entity has a mixed classification of this sort it raises other challenges. In reality, “dividing” a business is typically not handled the same way as other assets, as businesses typically cannot be liquidated and then distributed between the spouses.
In most cases, the valuation attributed specifically to community property is simply accounted for in the overall distribution process, and so one spouse will acquire other assets to balance things out. When businesses are involved in the division process, it’s commonplace for a financial expert – CPA or other expert – to provide formal valuation services. These services are often necessary to develop a useful or workable valuation for division purposes.
Contact the Drake Law Firm for Additional Resources
If readers want to know more about categorizing assets in Colorado, the property division process in general, or any other related matter, contact one of the family law lawyers at the Drake Law Firm today by calling us at 720-410-6781.