You can't be a great real estate investor if you don't have an understanding of marital property laws and how they affect your investments. Most U.S. states use common law, also known as or equitable distribution, as their matrimonial regime, but in Texas and eight other states, community property is the rule.
The principle of community property is that each spouse owns half the couple’s assets. It assumes that every contribution each spouse makes to the "marriage community" should be shared.
This means property, income, and other assets acquired by either spouse during the marriage belongs equally to each of them. It also means that in the event of death or divorce, each spouse gets an equal share of the property.
And before you ask me, yes, it also means that both spouses are accountable for the other’s debts.
Some exceptions apply to allow sole ownership of a property or certain assets:
Property one spouse acquired before the marriage remains that person’s sole property, unless it transmutes, or changes, to community property by:
It is important to note that in Texas and Idaho, income earned from separate properties is considered community property. In the other community property states, such income is considered separate. That bring me to our next section ...
Community property is the law in the following states:
Out of the nine states that use community property instead of common law, Texas is the only community property state that recognizes common-law marriages (not to be confused with common law property). In the other states, only legal marriages pertain to community property.
Property rights in some states, including Texas, may come into play in partnerships that resemble traditional marriages, e.g. by length of cohabitation or the raising of children together. Where separate ownership cannot be ascertained, the court m
ay rule on an equitable split, which is partly depending on how much each spouse contributed financial assets to the marriage (e.g. 40/60 or 30/70 instead of 50/50.) In California, the split must be 50/50.
For most people, it's an easy-to-answer question. Where do you live? Is it in a community property state or not?
But for may of us who invest in assets all over the country or all over the world, we have to look at other factors.
Yes, domicile, a person’s legal permanent address, is used to define where a couple lives, and therefore which state’s jurisdiction their property law comes under. This becomes important for couples that end up in the divorce courts if they have homes in more than one state, or are on the move regularly, e.g. from being in the military, or temporary work placements.
Some factors used to determine domicile include:
Community property has several tax benefits. In the event of the death of one spouse, both partners’ interest in the property get a "step-up" in basis. The property gets an updated tax basis on the market valuation at the date of their death. The deceased spouse legally has a half interest in the entire community property, so both halves of the property receive the step-up in basis, instead of just the deceased’s half.
Say a couple own a house with a basis of $50,000, the amount they initially paid. The house now has a value of $500,000, making each spouse's’ share of the house worth $250,000 with a basis of $25,000. The deceased spouse’s share now has a basis of $250,000. If the property were not community-owned, the living spouse’s share’s basis would remain at $25,000, and the total basis $275,000. In a community property state, each half would get the new basis of $250,000, giving a total basis of $500,000.
While community property has some tax benefits, it is easy to see the downsides to the system. But there are ways to protect your assets. When it comes to the potential for divorce, one way to avoid complications from community property laws is to draft a marital agreement, a.k.a. a "prenup."
A prenuptial, post-marital, or divorce agreement can convert community property into separate property in the event of death or divorce. Some states allow you to opt-out of the system without a pre-signed agreement, but others, such as California, are stricter, and there is the chance other states may follow suit. So it is best to sign a formal agreement under any jurisdictions.
Disputes can arise upon the death of a spouse, particularly if children are involved. Typically, if somebody dies without leaving a will, their half of the estate goes to the remaining spouse unless they had children from a previous relationship. In which case, the remaining spouse retains their half, but the deceased spouse’s half goes to his or her children.
Estate planning and making a will can help you or your family avoid extra stress in times of loss.
In community property states, if one spouse needs to file for bankruptcy, it must include all community-owned property. In many cases, judges will require the other spouse to declare bankruptcy too. Creditors can make claims against community property, and even against the other spouse’s individually owned properties.
Placing your property into a trust has several benefits.
Three states still have Dower Rights for spouses not on the title to a property. In Ohio, Kentucky, and Arkansas, a widow or widower is entitled to the interest or income from one-third of their deceased spouse’s property.
California land trusts aren’t subject to community property or dower rights, so are a great way to invest without the risk associated with the usual marital property laws in California.
Scott Royal Smith is an asset protection attorney and long-time real estate investor. He's on a mission to help fellow investors free their time, protect their assets, and create lasting wealth.
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