If you’ve received an inheritance during your marriage, you might assume those assets are protected from division upon separation. The BC Court of Appeal’s February 2025 decision in
Mills v. O’Connor, 2025 BCCA 34, provides crucial guidance on how courts should trace excluded property when it has been co-mingled with family assets over time. The difference in methodology resulted in a swing of nearly $700,000 in this case—demonstrating how important proper legal advice is when inheritances are at stake.
The Legal Framework: Family Property vs. Excluded Property
Under section 81 of BC’s
Family Law Act (FLA), separating spouses are presumptively entitled to an equal interest in all “family property.” However, section 85 carves out certain “excluded property” that is not subject to equal division—including inheritances received by a spouse at any time.
Here’s the critical catch: under section 84(2)(g), any increase in value of excluded property during the relationship becomes family property and is presumptively divided equally. As the Court noted, “the FLA clearly distinguishes between the initial value of excluded property and the value of that property as of the date of trial” (para. 51).
The Facts: From Vancouver Home to Insurance Proceeds
Mr. Mills and Ms. O’Connor’s relationship lasted approximately 23 years, with more than 20 years of marriage before their separation in March 2015 (para. 2). The case involved a complex trail of inherited assets transformed multiple times during the relationship.
The Inheritance
Following the death of Mr. Mills’ parents in 2001 and 2003, he inherited:
• The “Bellevue Property” in Vancouver, valued by the trial judge at $1,850,000 at acquisition (para. 10)
• Cash distributions totalling $137,112.23
• Securities worth $21,842.13
The Property Transformations
In 2004, Mr. Mills devoted himself full-time to renovating the Bellevue Property for resale. He obtained $1,000,000 in financing, for which Ms. O’Connor agreed to be a covenantor (para. 11). While Mr. Mills was the “primary driving force and operating mind” behind the renovation, Ms. O’Connor contributed by assuming primary childcare responsibilities for their three children (para. 42(g)).
In 2005, Mr. Mills purchased bare land near Merritt, BC (the “Monck Park Property”) using funds from the $1,000,000 loan (para. 42(i)). In 2006, the Bellevue Property sold for $3,650,000, with net proceeds of approximately $2,596,500 after fees and debts (para. 12). These proceeds funded construction of a family summer home on the Monck Park Property between 2006 and 2008.
After the parties separated in 2015, the Monck Park home was destroyed by fire on October 3, 2018 (para. 13). Mr. Mills received approximately $2,600,000 in insurance proceeds. In 2020, he unilaterally sold the bare land for $255,000.
The Central Issue: How to Trace Co-Mingled Property
The parties agreed that $3,084,542.63 was the total family property available for division (para. 57). The critical question was: how much of this could be traced to Mr. Mills’ original inheritance and therefore excluded from division?
The Court of Appeal noted this was “the first opportunity for this court to consider the appropriate approach to tracing in a family law context” where excluded property has been co-mingled with family property (para. 78).
Three Competing Tracing Methods
1. First-In, First-Out (FIFO)
Based on the rule from Clayton’s Case (1816), this approach presumes funds exit in the order they were deposited. The trial judge effectively used this method, concluding the entire $1,850,000 inheritance remained as excluded property (para. 93).
2. Lowest Intermediate Balance Rule (LIBR)
Under LIBR, a claimant’s interest cannot exceed the lowest balance in the fund after their contribution. The Court found this approach “can become complex and, therefore, costly to litigants” and requires tracking “essentially every transaction” over many years (paras. 88, 102).
3. Pro Rata Ex Post Facto
This method calculates the excluded portion as a proportion of total contributions to the final asset pool. A contributor’s interest is determined based on “the proportion of their contribution to the overall amount of contributions made over the lifetime of the intermixture” (para. 87).
The Court of Appeal’s Decision
Justice Abrioux, writing for the Court (with Justices Newbury and Grauer concurring), found the trial judge committed reviewable errors in her tracing analysis.
Rejecting “First-In, First-Out”
The Court rejected the FIFO approach, noting it has been “generally rejected in Canada” as “often unfair and generally arbitrary” (para. 93). The Court quoted Learned Hand J.’s observation that attributing losses based solely on timing “has no relation whatever to the justice of the case” (para. 82).
The Court emphasized that using FIFO “treats excluded property more favourably than family property,” which is inconsistent with the FLA’s foundational principle of equal sharing (para. 93).
Adopting the Pro Rata Approach
The Court held that “the relative—and important—simplicity of the FLA’s approach to excluded property indicates…that a pro rata ex post facto approach is appropriate” (para. 90). Key reasoning included:
“The presumption of equal sharing is foundational to the approach to property division taken in the FLA and is consistent with a principled understanding of spousal relationships as equal partnerships.” (para. 96)
The Court concluded: “it is appropriate, and in keeping with the requirements of the FLA, generally to approach the exercise of tracing excluded property through a co-mingling of family and excluded property on a pro rata basis” (para. 99).
The Calculation
- The Court traced the contributions as follows (paras. 104-106):
- Original excluded property: $1,850,000 (Bellevue inheritance)
- Increase from Bellevue sale: $1,800,000 ($3,650,000 – $1,850,000)
- Increase reflected in insurance proceeds: $681,565
- Proceeds from bare land sale: $255,000
Total contributions: $4,586,565, of which Mr. Mills’ excluded $1,850,000 comprises 40.3% (para. 106).
Applying this percentage to the relevant family property ($2,867,020.49, after subtracting Ms. O’Connor’s RRSP and the household contents insurance), the Court determined Mr. Mills’ exclusion was $1,155,409.26—a reduction of nearly $700,000 from the trial judge’s finding of $1,850,000 (para. 108).
The Final Property Division
The Court then considered whether equal division of the remaining family property ($1,929,133.37) would be “significantly unfair” under section 95 of the FLA. Key factors included (paras. 142-145):
- The length of the marriage (over 20 years)
- Ms. O’Connor’s role as primary caregiver, enabling Mr. Mills to pursue opportunities
- The parties’ “joint family venture” in renovating and developing the properties
- The excluded property’s centrality to the family’s economic circumstances
Finding that equal division would be significantly unfair, the Court ordered a 65/35 division of family property in Ms. O’Connor’s favour (para. 148). The final result:
Ms. O’Connor: $1,253,936.69
Mr. Mills: $1,830,605.94 (including his exclusion)
What This Means for You
If You’ve Received an Inheritance
Keep meticulous records. Document exactly when and how much you inherited, and track every transaction. The Court noted that detailed transaction-by-transaction accounting “would necessitate a detailed consideration of essentially every transaction the parties conducted, over the course of many years” (para. 102).
Consider keeping inherited assets separate. While not always practical, maintaining inherited funds separately can simplify tracing and protect your exclusion claim.
Understand that growth becomes family property. Under section 84(2)(g), any increase in value during your relationship is presumptively divisible.
If You’re Going Through Separation
Challenge inflated exclusion claims. Mills v. O’Connor now establishes that the pro rata approach is generally appropriate—which often results in a lower exclusion amount than FIFO would yield.
Remember the burden of proof. Under section 85(2), “a party claiming that property is excluded is responsible for demonstrating that” (para. 98). In this case, Mr. Mills failed to prove exclusions for inherited cash and securities because he lacked documentary corroboration (paras. 126-128).
Key Legal Principles Established
- Pro rata ex post facto is now the preferred tracing methodology in BC
- “First in, first out” tracing is generally rejected as arbitrary and unfair
- The FLA favours simplicity over detailed transaction-by-transaction accounting
- Equal sharing remains the foundational principle—tracing methods should not artificially prefer excluded property over family property
- Documentary evidence is essential to prove exclusion claims
Conclusion
Mills v. O’Connor provides the first comprehensive guidance from BC’s Court of Appeal on tracing excluded property through co-mingled funds. The decision reflects the FLA’s underlying philosophy that marriage and common-law relationships are equal partnerships, and tracing methodologies should not artificially favour one spouse’s exclusion claim over the other’s share of family property.
If you’re navigating property division involving inheritances, gifts, or other excluded property claims, the stakes are high and the law is technical. Professional legal guidance can help ensure you receive—or protect—what you’re entitled to under the law.
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Disclaimer: This article is for informational purposes only and does not constitute legal advice. Every case is unique, and the outcome of your matter will depend on its specific facts. For advice about your particular situation, please consult a qualified family lawyer.
Case Citation: Mills v. O’Connor, 2025 BCCA 34 (CanLII) — Decision date: February 4, 2025