Tom and Judy live in a four-bedroom house in Berkeley that they think of as belonging to both of them. Tom bought the house 20 years ago and after he met and married Judy, he never thought to do anything different when the property tax bills kept coming in his name alone. He simply paid those bills out of their joint checking account, the one they both deposited their paychecks into.
Well after Tom’s and Judy’s kids from previous marriages had long since gone off to college, Tom and Judy made their way to an attorney’s office to start planning their wills and trusts. The attorney asked to see a copy of the deed to their house so that she could make a new deed, putting the house into their couple’s revocable living trust. Lo and behold, the attorney pointed out to Tom and Judy that the house is titled only in Tom’s name.
Does that mean the house belongs to Tom alone? Or by virtue of their considering it their joint property, does that make it so?
Tom bought the house as a single man, and it was entirely his separate property until the day he married Judy. From that day forward, the house remained virtually Tom’s separate property. It did not become Tom’s and Judy’s community property the day they married. However, the house had, and continues to have, a mortgage on it. Every time Tom and Judy make a mortgage payment, or pay property taxes, or make a repair on the house, Judy is gradually acquiring a community property interest in Tom’s separate property asset. If they are ever unfortunate enough to get a divorce, Tom’s going to claim the house is “his” because only his name appears on the deed. Judy’s going to claim that the house is at least partially community property – and that she ought to get some portion of its value – because she’s been contributing to the mortgage and the upkeep of the house.
This may sound more confusing than it actually is. What’s surprising is how few Californians, married or single, understand the fundamentals of our state’s community property laws.
Under California law, community property is what is acquired by earnings by married persons – and, under recently enacted laws, registered domestic partners – during the time of marriage (or the period of registration.). Property includes not only real estate which is known in the law as real property but also personal property: cash and its equivalents as well as all of the tangible items one has, from cars to computers, jewelry, artwork, furniture, etc. Whatever Tom and Judy owned before the date of their marriage was and is their separate property. Whatever either of them may have inherited from their families or received as a gift is also their separate property. Each time either of them earn a paycheck, that’s community property, as is the interest that accrues on their earnings when they put their earnings in a savings account.
The house, over time, has developed a mixed character. It started out as Tom’s separate property asset. But each time either of them paid the mortgage, property taxes, or anything associated with that separate property asset, Judy began to acquire a community interest in what began as Tom’s separate property. (If Tom used separate property to pay down the mortgage that would be a separate property of contribution.)
Why does the distinction between community and separate property matter?
In a divorce it would make a very big difference if Judy didn’t own a 50% interest in the house but rather only a fraction based on the amount of value that could be traced to the couple’s payments from earnings during the time of their marriage. In estate planning it matters because one can bequeath one’s separate property to whomever one wishes, but one cannot bequeath one’s spouse’s half of one’s community property to anyone other than the spouse.
Let’s say that Tom wanted to make sure that upon his death, the full value of the house would go only to his children and not to Judy or her kids. He can’t do that in his estate plan if Judy, or Tom through earnings, have been contributing to the mortgage during the course of their marriage – unless they had a pre- or post-nuptial agreement stating that their intention was for the house to remain Tom’s separate property.
What if Tom’s intention was to make sure that the house belonged solely to Judy upon his death? If most of the value of the house were his separate property – because he had made the initial down payment and paid off most of the mortgage before marriage — Judy might think the house were hers but Tom’s kids could make a separate property claim on a portion of its value (unless Tom’s estate plan gave his separate property to Judy.) Without an estate plan, Tom’s kids might make a claim that they owned a large portion of the value of the house. What a mess that would be for Judy.
The estate planning attorney, upon seeing that the house was in Tom’s name only, though the couple had been married for many years, asked the clients what their intentions were. They said they considered the house “theirs.” But did Tom really want to give Judy half the house when she had not contributed to its original down payment?
Their answer was “yes.” They also wanted to make sure there would never be a doubt that they owned the house equally, even if that meant a windfall for Judy in the unlikely event of their divorce. They also wanted to make sure that if Tom died first, Judy would get the advantage of the house getting a full “stepped up basis” to the value on the date of Tom’s death, thereby reducing or eliminating any capital gain taxes if she went to sell it.
The solution was for Tom to execute an “interspousal” deed that explicitly “transmuted” the character of the house from separate to community property. This needs to be done via an “express declaration” and it can be done in a separate document or in the language on the deed itself.
In high stakes situations, the attorney would have advised each of the spouses to speak to their own separate attorneys about changing the character of property from separate to community. In this case, the attorney was satisfied that this “transmutation” was what Tom sincerely wanted to do, and she added that fact to an advice letter she asked both partners to sign.
Once the character of the property was changed, via a deed, to community property, then a second deed would re-title the property in the names of both spouses, as trustees of their revocable living trust. Holding their property this way meant that when one spouse died, the house already belonged to the other spouse. Their trust stated how the proceeds of the house would be divided between the couple’s respective heirs upon the death of the second spouse.
Community property law was adopted byCaliforniaearly in its history as a progressive legal arrangement for protecting a spouse not working outside the home. If the title on a piece of real property or a bank account were the only way to determine “ownership,” then men historically would have owned everything and stay-at-home wives/mothers would have owned nothing unless their husbands added their name on title, even though working as unpaid homemakers is work. Community property law means if you’re married, you’re protected from being “terminated” in a marriage, by death or divorce, with no claim on the earning spouse’s wealth.
This is the protective aspect of community property law. It also means one needs to be mindful of the financial implications of getting married or registered as a domestic partner because from date of marriage/registration forward, everything one earns then belongs half to someone else. The debts of a spouse/registered partner also become a potential problem, as creditors can seek payment first from the separate property of a debtor and then from what a couple owns as community property and even the separate property of a non-debtor spouse or partner. Be careful about whom you marry! Watch out if they have large debts.
Community property law can be a double-edged sword, protective of a financially weaker spouse or partner, treacherous if one wants to keep one’s property separate. Pre- and post-nuptial agreements can be used by spouses to agree that their financial relationship need not conform to the default rules of community property law.
Married or thinking about getting married, everyone needs to understand what how changing one’s marital status changes one’s relationship to the things one owns.
