When working out a divorce settlement, property valuation is often part of the process. It is especially important to determine the value of community property assets.
This includes all wages, savings, investments and any other property that has been acquired during the marriage. However, it is sometimes hard to determine what is separate and what is community property.
Community Property States
In community property states, spouses own (and owe) all income and assets acquired during their marriage. This includes wages, salaries, and investments. It also includes real and personal property, such as vehicles and homes. The only exceptions are assets that a spouse owned before marriage or acquired after a legal separation or divorce. In addition, separate property includes gifts and inheritances that a spouse receives during the marriage. It’s possible to comele separate and community property by adding assets one spouse owns before marriage into the community property or putting joint names on title documents or bank accounts.
In divorce or death, a court divides all community property 50/50 unless the couple agrees on another arrangement. The character of an asset as separate or community property carries over to any income received from the asset, proceeds of sale, and new assets bought with those funds. In addition, creditors of a debtor spouse can reach the debtor’s separate property.
Gifts and Inheritances
When planning an estate, spouses and domestic partners must carefully consider whether assets are community property or separate property. In general, community property encompasses all income earned or assets acquired during a marriage (and sometimes before separation), as well as any funds in joint bank accounts and retirement and savings accounts. However, determining what is community and separate property can become complicated when gifts and inheritances are involved.
In community property states, these assets are considered part of the marital estate and belong to both spouses equally regardless of whose name is on the title. Separate property includes any assets purchased or owned before marriage, assets bought with separate funds and never used for the benefit of the other spouse, and any assets that increase in value due to contributions from a separate property source. Determining the property characterization is particularly important for tax purposes, as it influences how and to whom assets are distributed in divorce or death.
Commingling
If separate property is not carefully preserved and kept apart from community property, it will likely lose its character as separate property. This is known as “commingling.” For example, if Spouse A owned a certificate of deposit before marriage and deposited the proceeds into a joint bank account with Spouse B during marriage, the separate property portion of the CD could be changed into community property (transmuted) by that act.
Similarly, if a separate property asset increases in value because of the application of community property funds or labor (such as when a carpenter builds an addition to the home), that increase may become community property. A divorce attorney can help a client determine whether commingling has occurred. Moreover, the law does not always allow spouses to keep books and records that can clearly show what assets are separate property and what are community property. This can make it difficult to prove in a case where there is a dispute over the division of property.
Taxes
The big difference between community property and separate property is how the property is taxed. If you buy something with community property and it appreciates in value, you get a step-up in basis and only pay taxes on the appreciation amount. That’s not the case with separate property.
Separate property includes anything you owned separately before marriage or purchased with separate funds, gifts given during marriage, personal injury awards, certain inherited assets and income from separate property. Community property includes all other income and property acquired during a marriage or domestic partnership, except for inheritances and gifts and any property the spouses inherited before marriage.
It is possible for some separate property to transmute into community property by commingling or mixing it with other community property. That can happen intentionally by agreement or unintentionally. An example would be if you had a bank account with separate property and it mixed with community property by commingling and was not segregated, it would become community property.
