One of the more common phrases we hear from clients is, “I wish I had known this sooner!” This often comes up in connection with a decision that determines whether certain property is treated as community property or separate property in a divorce. Engaging in some smart, simple planning on the front end can not only save litigants time and money, but also increase the predictability of the financial outcome and reduce stress during the divorce process.
Because the law presumes all property owned by spouses to be community property, proving that property should be treated as separate can quickly become an expensive undertaking. To reduce the number of times “I wish I had known this sooner” is woefully uttered to a family law attorney, here are some practical tips to protect and maintain separate property.
First, however, let’s define separate property. Separate Property (which we will also refer to as “SP”) includes the following:
- property owned before marriage;
- property acquired during marriage by gift or inheritance
- property acquired during the marriage as compensation for personal injury damages in certain situations, and
- community property made separate by a premarital or post-marital agreement.
All other property owned by a spouse is community property (which we will also refer to as “CP”) which can be divided by the court in a divorce. By contrast, the SP is awarded to a spouse independent of the division–if that spouse can prove the property is SP by clear and convincing evidence. Here’s how to show the court that property should be considered separate.
If hypothetical husband David deposits $100,000 he received as an inheritance from his mother’s estate into a joint account he holds with hypothetical wife Deborah that already has $100,000 of community property, David’s SP inheritance has now been commingled with community property funds in a joint account. To establish his clear and convincing evidence burden, David must trace the funds through this account from the time he deposited his inheritance through the date of divorce. Not only does this typically require a forensic financial expert, if the SP deposit was made in 2007 and the divorce is filed in 2020, David is going to have a difficult time tracking down statements going back thirteen years. And the law generally requires that he have each statement for each month of the entire period. To avoid this, the following steps can be taken:
- Do not comingle your SP with your spouse’s property. Set up an SP account (or accounts) solely in your name. Do not set your spouse up as a signatory on the account. And even though the name of the account doesn’t establish the SP character of the contents, we recommend that you add “Separate Property” to the name of the account, so that you (and anyone else who might help manage your accounts) are very aware that this is SP, and you handle it accordingly.
- If you receive an inheritance, you should set up a new SP account with those funds (or you can put them into an already existing account which is titled as an SP account.
To be clear, we are not saying that you cannot enjoy your money. If you want to use some of that inheritance/separate property to take your family on that dream vacation, go for it. Just do not expect that amount to be paid back to you as your separate property if you find yourself in a divorce case, and we would rather a potential litigant know this before making the decision to take that dream vacation.
In the hypothetical set out above, David should have set up a separate account and deposited his $100,000 inheritance there. But even then, David risks unintentionally commingling because the funds will likely bear interest. That interest is considered income, and income from SP is considered CP (unless you have a premarital or post-marital agreement that states otherwise).
- If you do not have a premarital agreement or post-marital agreement establishing that income from your SP is SP, then your SP accounts should be set up so that interest is transferred to a community account as the interest is incurred. This is called an interest-sweeping account. This further ensures that you do not commingle your SP.
If David had instead taken his $100,000 over to “Mike the Money Manager” and used it to buy stocks or bonds, David still risks unintentionally commingling his SP funds as a number of stocks, bonds, and funds issue dividends to stockholders. These dividends are commonly used to reinvest and purchase additional stock; however, cash dividends, like interest, are considered CP. As such, over the years, David might have unintentionally commingled what he thought was an SP brokerage account, and he would need to trace those individual stocks and bonds in order for a court to find it to be his SP Sometimes even with all the records, this is very difficult or impossible to do.
- Once again, the stocks or bonds need to be set up so that the dividends are swept into a CP account (unless you have a premarital or post-marital agreement that sets out that the dividends are SP).
- If you inherit stocks or bonds, those accounts need to be set up so that the dividends are swept into a CP account (unless you have a premarital or post-marital agreement that sets out that the dividends are SP).
What happens when you purchase something with your SP? Provided you can prove that you paid for it with your SP (that has not been commingled), it should be your SP. But what happens when you put your spouse’s name on it? It can be claimed that you gave your spouse a gift of 50% of that property purchased, as his or her SP.
- So, do not put your spouse’s name or anyone else’s name on something that you purchase with your SP—either alone or with yours (unless you are intending to give them a gift). SP purchased should only have your name on it. Sometimes the person or business you’re buying something from will want to simplify and have both names on the title; however, you can insist on it being only in your name.
- Do not transfer funds from an SP account into a CP account before making the purchase. Sometimes it seems simpler to do this, and it doesn’t by itself turn the SP into CP, but it can create a presumption of CP which can be complicated to prove otherwise. It’s much better to go straight from your SP account for SP purchases and from a CP account for CP purchases.
- If part of a purchase involves creating debt, be sure that the lender agrees in writing that they will look only to your SP for repayment. Otherwise, the portion of the asset that you purchased with debt (i.e. a purchase money mortgage for real estate) could be considered community property.
Disposition of Property
What do you do when an item of SP is sold? Make sure you deposit the proceeds directly into an SP account.
Keep your Records
In these days of electronics, it is much easier to keep your records than it used to be. We would recommend that you keep all statements received on all of your accounts from the date of your marriage, on your computer or in paper files if you prefer. Remember that it is important to have a backup system so that your records are not lost in the event of a computer crash. Better to have all of your records and not need them — than to not have them and need them. Consider utilizing a cloud-based service such as iCloud Drive, Google Drive, Dropbox, Box, and OneDrive that would allow you to store electronic backups of your documents. Some of these services do charge a monthly fee while others offer a certain amount of cloud storage for free.
Premarital or Postmarital Agreements
A premarital agreement can be an effective tool for securing and protecting SP. For example, it can provide that income from SP will remain SP, so one would not have to bother with interest-sweeping accounts or cash dividends. Additionally, when neither spouse brings assets into the marriage, but one spouse receives an inheritance, a post-marital property agreement can be prepared that will do essentially what the premarital agreement does for someone coming into the marriage with a considerable amount of SP.
There are many twists and turns on the road to protecting SP. Whether you owned a home prior to marriage that is being sold, you are considering starting a new business, or you inherited a fortune from your Uncle Charlie during your marriage, there are ways to protect your SP. More often than not, mistakes are made throughout the course of a marriage that make confirmation of your SP more challenging and expensive. Even if divorce isn’t on your radar at all, it is often a worthwhile endeavor to talk with a family lawyer to assess your SP situation and provide you with concrete advice on how to maintain it.