Community and separate propertyIt is often estimated that approximately half of all U.S. marriages end in divorce. While some may consider this statistic to be common knowledge, what is less well-known is how divorcing couples should go about dividing their assets and liabilities. Thus, “Yours, Mine, or Ours?” is a three-part saga that explores the story of Bob and Helen – and the financial implications of their impending divorce. In Part 1, we discuss the community and separate property laws that could impact Bob and Helen’s transition. Part 2 reveals the challenges associated with identifying and valuing marital tax values. In Part 3, Helen finds out the potential income tax consequences of the divorce.

The Story of Bob and Helen

Bob and Helen, both Texas residents, find themselves consulting divorce attorneys after 30 years of marriage. Both are convinced that going their separate ways is the only viable option, but Helen is concerned about her future. She suspects that Bob secretly conducts some of the business in cash and omits these transactions from their company’s books and records. What happens now?

When Helen meets with her attorney, Javier, she discovers that not all assets and income items are treated the same in the eyes of the law. By asking Helen a series of questions, Javier learns the following about the family’s history:

  • Helen, a lifelong Texan, began working as a flight attendant after graduating from college.
  • Bob moved to Texas from New York and joined that same airline as a pilot.
  • Bob and Helen participated in their employer-sponsored retirement plans and contributed the maximum allowed every year.
  • Two years after they met, they got married and began living what they believed was their “American dream.”
  • Weeks after Bob and Helen’s 10th wedding anniversary, Helen’s parents died in a tragic incident while on vacation. A wrongful death lawsuit resulted in Helen receiving $5 million from her parents’ estates.
  • After Helen received her inheritance, she and Bob left their employer and started their own travel agency. They formed an S-corporation and used some of the money Helen inherited from her parents to build a successful business.
  • Helen used another part of her inheritance to purchase a beach house that the family uses each summer and rents to tourists when they are not using it.
  • Helen bought stocks and bonds with the rest of her inheritance. She reinvested the capital gains, dividends, and interest earned on the account.
  • For several years, Bob’s parents give him $10,000 cash every Christmas. Bob invested these gifts into the travel agency.
  • About 10 years ago, Bob’s parents gave him $500,000 in stocks and bonds that are now worth $900,000. Bob added these securities to Helen’s brokerage account.

Javier explains that state statutes define community and separate property, and the definitions vary by jurisdiction.

Dueling Distinctions: Community Property vs. Separate Property

“Community property” refers to certain property that both spouses own together. In the absence of specific evidence to the contrary, the law generally presumes joint ownership of all income and assets acquired during the marriage. Some examples of community property and income include:

  • property purchased while married and living in a community-property state,
  • property acquired with community income,
  • income earned by either spouse during the marriage, and
  • certain gains from selling community property.

By contrast, separate property belongs to only one spouse. In a divorce, separate property goes to the spouse who owns it. The following assets are considered separate property:

  • property owned before the marriage,
  • inherited property,
  • income earned before the marriage,
  • certain gains from selling separate property, and
  • any gifts one spouse gives to the other spouse.

Sometimes, separate property is mixed, or commingled, with community property. When this happens, tracing the payment histories may show the percentages (or amounts) of the asset that are either community or separate. Unless there is evidence to prove otherwise, commingled property is treated as community property.

The States Have Their Say

The following states have community property laws:

  • Alaska (Note: Alaska gives both spouses the option to make some or all of their assets community property.
  • Arizona
  • California
  • Idaho
  • Louisiana
  • Nevada
  • New Mexico
  • Texas
  • Washington
  • Wisconsin

Some states, such as California, strictly mandate an equal division of community property between divorcing spouses. In other states, such as Texas, the judge presiding over the divorce may decree an equitable distribution of community property. However, what is “equitable” in the eyes of the judge may not be an equal split.

The Final Word on Bob’s and Helen’s Property

Given the regulations in Texas, Javier tells Helen that she will most likely be entitled to her share of the community assets, as well as all of her separate property. Bob will continue owning all of his separate property and will receive his share of community assets. Javier draws the chart below to help Helen understand the types of ownership that she and Bob have over their assets.

AssetBob’s Separate PropertyCommunity PropertyHelen’s Separate PropertyMixed/Commingled Property
Airline retirement accountsX
Beach houseX
Bob’s gifts from his parentsX
Brokerage account/stocks and bondsX
Capital gains and capital gain dividends on brokerage accountsX
Helen’s original inheritanceX
Income from travel agencyX
Interest and ordinary dividends on brokerage accountX
Rental income from beach houseX
Travel agency businessX

 

Javier tells Helen that her CPA can help value the couple’s businesses and find separate property that may have been commingled with community assets or community income. They agree to meet again to decide how to proceed.

CRI Can Help You Determine Your Community and Separate Property

CRI’s professionals understand the potential consequences of dividing separate and community property when couples divorce. Our advisors can provide separate property tracing, business valuation services, and techniques to help avoid commingling separate property. If you need tax planning or other financial services related to separate property or a divorce, then please contact us today.