Community Property or Separate Property? Why Does It Matter?

Property obtained during a marriage is called marital property. This property can include anything from real property like homes and rental properties, to stock options, investment accounts, heirlooms, and employment income.

Some spouses want to share their property with each other. Others have reasons to not automatically share or transfer ownership to the other based solely on the existence of the marriage. State law can be a large factor in whether marital property is shared or not.

Assets acquired during a marriage are classified as either community property or separate property. This classification is based on two factors: where you live and where the money and property are located.

There are currently nine community property states: Texas, Arizona, Washington, New Mexico, California, Nevada, Idaho, Wisconsin, and Louisiana. In these states, the property obtained during the marriage is, by default, legally classified as belonging to both spouses equally regardless of what the property’s title or deed says. The only exceptions to this treatment is if the property were obtained prior to the marriage, obtained during the marriage as an inheritance or gift, obtained during the marriage with money or property from separate property, or its characterization is governed by a pre- or postmarital agreement.

Money and property that is deemed separate property before marriage remains separate property unless the spouse commingles the property with funds or property acquired from community property. Commingling happens when money and property from one source is mixed with money and property from another source.

Most states are considered separate property states (also called common law states). The default characterization in separate property states is that property obtained during the marriage is not automatically deemed community property. Instead, whether money or property is characterized as separate property depends on what the title or deed says. This means that the property belongs to the person who purchased it unless certain other factors exist.

There are also a few states, including Alaska, South Dakota, and Tennessee, that have elective options that allow its residents (and in some cases, even nonresidents) to opt into a community property system or transfer property into a trust for community property. In addition, some separate property states such as Florida have recently enacted community property trust acts to allow residents to take advantage of certain tax attributes of community property.

Problems that Can Arise

The implications of separate and community property are seen when there is a death or divorce. These events require the identification and segmentation of property. During a divorce in most states, legal determinations are made about money and property to help ensure equitable distributions of property and money for each person. At the time of a death, the legal determinations are necessary to ensure that inheritances are distributed in an orderly fashion. Issues can occur during death or divorce based on whether you are located in a community property state or separate property state, the expectations of the parties involved, and disagreements that can occur.

Potential Problems in Divorce

Common problems that occur in a divorce arise when one spouse believes that they have an ownership interest in property and their soon-to-be ex-spouse does not agree. Are different assets that they accumulated during marriage to be split equally? The outcome may turn first on where the couple lives. If they live in a community property state such as California, the default rule is that all the money and property acquired during the marriage, including assets they may have titled separately, belongs to each spouse equally. However, in Michigan and other separate property states, assets titled separately during the marriage would be considered the separate property of the spouse whose name the assets are titled in. The couple, or the divorce court, could then decide if the spouses keep their separate assets or if they are divided as part of a divorce property settlement.

Potential Problems in Death

At the death of a spouse, the classification of assets as community property versus separate property has significant implications. How assets are transferred and who has access to various assets can hinge on the classification. In community property states, money and property acquired during marriage are classified as being jointly owned and will pass to the deceased’s spouse. In separate property states, this transfer is not automatic. There is no guarantee that the surviving spouse will receive the property of their deceased spouse. But keep in mind, most states have some laws in place to keep someone from completely disinheriting their spouse.

Some may view the automatic transfer of property to a surviving spouse as a positive outcome. However, consider the following scenarios:

  • An estranged couple no longer communicate or cohabitate but have not obtained a divorce. All their friends and family members are aware of the disintegration of their relationship. Eventually, one spouse passes away. In a community property state, the estranged spouse would get control over money and property that the deceased spouse may not have given to them.
  • A man with two adult children from a prior relationship marries a woman with no children. His children and his new wife do not get along. He suddenly passes away. In a community property state, absent instructions stating otherwise (i.e. a marital agreement and an estate plan), his wife inherits his accounts and property that are classified as community property, and, contrary to his wishes, he inadvertently blocks his children from receiving any benefit from the community property.

 The outcomes in these situations will differ based on the specific state statutes; however, the scenarios reveal the potential conflicts.

Potential Challenges when Moving

The laws regarding how property is categorized differ from state to state. As a result, moving from one state to another must be handled with care and counsel. State law determines how your property will be treated. Some community property states allow property to maintain its separate property characteristics if moving from a separate property state, while other community property states do not. On the other hand, when a couple moves from a community property state to a separate property state, the community property retains its status unless other steps are taken.

Proactive Planning

If you are married, the classification of your property and the resulting implications is a very important consideration. The most important thing a couple can do to avoid these complexities is communicate with each other and work with an experienced estate planning attorney to create a comprehensive estate plan. Schedule an appointment with us and we will help you understand and plan for these and other important factors.