In addition to the possibility of being hidden, assets have another inherent problem in the context of the divorce process — valuation. This is so because different standards of value may be applied for different purposes. Below is a summary of the different standards of value that may be applied to a particular asset in a divorce.
Fair Market Value
The standard of value that is most commonly used in divorce situations is fair market value. “Fair market value” typically is defined as “what a hypothetical willing buyer would pay a hypothetical willing seller.” This standard has a long history of interpretation by the IRS, business valuators, and the court system. It has also been abused, misused and misinterpreted by virtually every entity that has had occasion to use it. For purposes of discussion in this article, assume that the item in question is a six-year old dining room table. Under the fair market value standard, the value of the table would be the sales price of the table on the open market. In other words, what sales price could be expected if the table was advertised in the local paper for a couple of months? Used furniture usually is not very valuable; if the owner has pets, the furniture may have no value. Therefore, a six-year-old table with an original purchase price of $8,000 may sell for $1,000 or less. Consequently, the fair market value of the table that should be included in the marital estate is $1,000.
The term “purchase price” refers to the historical cost of an item. In our example, the table was purchased for $8,000. Therefore, under the purchase price standard of value, the declared value of the table would be $8,000. It would not be unusual for one party to a divorce to rely on the purchase price value of the table ($8,000) and the other party to rely on the fair market value ($1,000). In fact, this is a typical example of how the application of different standards of value can be a problem in marital estate valuation.
If our table was owned by a business, its “book value” would be the purchase price less depreciation. Assume that the business was writing off (expensing) the table over an eight-year period, and the depreciation per year was $1,000 (8,000 ÷ 8). Total depreciation on the six-year old table would be $6,000 (6 x 1,000). Thus, the “book value” of the table would be $2,000 (8,000 – 6,000).
“Replacement price” refers to the cost of replacing an asset. In our example, assume that the wife claims she will have to spend $10,000 to replace the table after the divorce is final. Consequently, she values the table at $10,000. A party’s motivation is something to consider when evaluating replacement price value. If, for example, the wife assumes the husband will get the table, she may be motivated to have it assigned a high value. If, however, the wife assumes she would end up with the piece, it is highly possible she would select some other standard of value.
People develop emotional attachments to property. This may be because of the association of the property to a beloved individual, or because it represents evidence of achievement, or simply because some individuals define themselves by their possessions. This value may defy comparison to any logical valuation standard, and may be a significant complicating factor in the valuation and division of a marital estate. In our example, if we assume the table was a gift from the wife’s mother and that it has very special meaning to the wife, it might be that the wife places a very high value on the piece which bears no relation to its actual worth. She might not be willing to declare the value as being high, but in fact would be willing to trade assets worth $12,000 to make sure she received it.
In order to expedite the divorce proceedings or simply because of missing information, one or both parties may guess at the value of an asset. These guesses may be informed or not. Assume, for example, that the husband has no idea what the table is worth; thinks arguing about it is ridiculous; and estimates its value at 50% of the purchase price, or $4,000. Caution: an “estimate” by an uninformed or adversely motivated party may be, at best, a fiction or, at worst, a tool of vengeance.
“Synergistic value” refers to the fact that an asset may have value to a particular buyer. This means that one buyer is willing to pay more for something than anyone else because it provides him or her with an economic advantage. (Compare this with “fair market value,” which considers the value of an item to a hypothetical buyer.) For example, assume that there are two competing companies in the same town. Company Alpha is willing to pay more for Company Beta than anybody else because owning both companies will eliminate all competition, giving Company Alpha a monopoly. In our divorce example, assume that the table was part of the dining room set of a famous movie star who died under mysterious circumstances at the table. Assume also that a collector has all of the chairs and other pieces of the dining room set, but not the table. The collector knows that if he can complete the set, his collection will skyrocket in value. Therefore, he is willing to pay more for the table than anybody else, say $25,000.
The term “fair value” is normally dependent upon context. It can be used in court and can be a point of law. That is, it is the court’s responsibility to determine what would be a fair value under the circumstances presented. For example, the court might decide that a fair value for the table in our example would be $25,000. That is, in the circumstances of the case, the table should be valued at the price that could be obtained from the collector. Unfortunately, the court may refer to this value as “fair market value” when, in fact, it is a “fair value” or value to the collector or value in the circumstances. It is not fair market value. Fair value might also refer to a statutorily-defined value. For example, a statute (a law on the books) might indicate that a fair value for a partnership must be determined before a partnership can be dissolved. That fair value may be the fair market value, or whatever the partners feel is fair in the circumstances, or what a judge may believe is fair.
What is the effect of the different valuation standards on a divorce?
The existence of multiple standards of valuation is an inherent problem in a divorce because it complicates the process of valuing the marital estate. For example, the si-year-old dining room table we have been discussing could have the following values:
|Fair Market Value||$1,000|
|Fair Value||$25,000 (?)|
Understanding the differences between the standards of value and the circumstances under which each standard may be present will allow your divorce lawyer and/or investigator to use balance sheets for analytical purposes, including the summary and division of the marital estate.