In Community Property states (AZ, CA, ID, LA, NV, NM, TX, WA, WI), assets acquired during marriage are considered to be jointly owned regardless of how the account or asset is titled. Separate property includes assets which pre-date the marriage as well as inheritances and gifts received during the marriage. In the case of a divorce, community property is split equitably while separate property will remain with its original owner.
Assets are considered to be community property unless you can provide clear and convincing evidence that they are separate. You may have heard that you only need to keep your financial records for six years, as that is the length of time that the IRS can go back for an audit (unless you submitted a false or fraudulent return, in which case there is no statute of limitations). However, for the purpose of proving separate property, you have to keep documentation permanently.
It is important to also understand that income from separate property is considered community income in Texas. If funds are commingled, contributions added, or dividends reinvested, you may inadvertently cause separate property to become characterized as community property.
When a couple is getting married, it is important for both spouses to understand their individual separate property rights and to take steps to ensure that their assets maintain their separate property character. We suggest having all income, such as interest and dividends, swept from the separate account automatically when received and deposited into a joint account. Capital gains from mutual funds can be reinvested, and of course, you can sell one position and use the proceeds to purchase another another one in the account.
In Texas, we have an “inception of title” rule which means that any asset acquired before marriage is separate, even if debt for the asset is discharged with community income. For example, a home purchased before one day before the wedding will forever be a separate asset, even if the mortgage is paid during the marriage. The same applies for a business entity – if created before the marriage, it will be separate property, and if created during the marriage, it’s a community asset, regardless of debt or title of ownership. Debt can be a part of community property, so any debt acquired by one spouse during marriage may be considered to be a joint debt.
Separate Property can sometimes be an issue for first marriages, however, most first marriages are with young couples who have little or no assets. It’s a more common concern for couples getting married (or re-married) in their 40’s, 50’s, or later who may have substantial separate property and who often have children from a previous relationship. These issues could be addressed by a pre-nuptial agreement, and if you do decide to have a pre or post-nuptial agreement, both spouses should have separate counsel. The nine states which do have community property laws, all have slightly different rules, so be sure to use an attorney and advisor who are familiar with your state’s laws.
If you’re getting married or remarried, your financial advisor should be having these conversations with you well in advance of the marriage and be taking steps to ensure your separate property rights will be maintained.