Separate vs. Community Property: Why Does It Matter?

Currently, there are nine (9) states that are considered “community property” states. Since I am licensed in and have clients in Texas and New Mexico (both community property states), I thought a discussion of the distinction between the two would be pertinent.Community property can only exist between husband and wife. You should not confuse community property with jointly owned property. Anyone can jointly own property, whether married or not.

The main rule that you need to be aware of is that property is classified at “the inception of title”. It does not matter that only one spouse’s name is on a bank account, a property deed, an investment account, or a vehicle. Everything in community property states is deemed to be community property, unless an exception applies. Even if an exception applies, you must be able to “trace” the property, a difficult thing to do unless you keep excellent records.

The classification of your property has important ramifications in the context of death, divorce, creditor issues, etc. This article will discuss what property is considered community property, what property is considered separate, the differences between the two from a legal perspective, and why you need to be aware of how your property is classified.

What is Community Property?

Community property can best be defined as everything acquired after the date of marriage. Said another way, community property is everything a husband and wife own together. This definition has several important exceptions that will be discussed in a moment.

Community property consists of:

  • Income earned by either spouse during the marriage
  • Any real or personal property acquired with income earned during the marriage (including vehicles, homes, furniture, appliances, and luxury items)
  • Dividends, interest, and capital gains earned on community property
  • Dividends and interest earned on either spouse’s separate property during the marriage
  • Any debts acquired during the marriage

Under community property rules, spouses own – and owe – everything equally, regardless of who earns or spends the income.

What is Separate Property?

Separate property includes any of the following:

  • Owned by a spouse before the marriage
  • Income earned by either spouse prior to the marriage
  • Capital gains on separate property, such as appreciated stock
  • Any property acquired by gift, will, or inheritance
  • Property purchased during marriage with separate funds
  • Personal injury damages for physical injury sustained, even while married (except for lost wages which are community property)
  • Community property partitioned or exchanged by written agreement

Can Separate Property Become Community Property?

Yes! As previously discussed, income that is generated from either spouse’s separate property is considered to be community property. Further, if you commingle your separate property with a spouse then it transforms its characterization to community property. This typically occurs in the context of gifts or inheritances. If you receive a gift or inheritance and place it into a joint bank account with your spouse, then the property automatically becomes community property.

Can Property Be Both Separate and Community?

It is possible for property to be characterized as both separate and community. Let’s assume you purchase a house for $100,000 during your marriage. You use proceeds from the sale of your separate property to put a down payment of $25,000. This 25 percent would be your separate property. However, if you make mortgage payments out of income earned during your marriage, 75% of the home would be owned by the community.

Are All of My Assets Either Separate or Community?

Yes. The separate/community distinction applies to assets, debts, business interests, pensions, 401k plans, IRAs, annuities, and life insurance. For life insurance, the character of the property is based upon the marital status when the first premium payment is made. Retirement plan benefits accumulated prior to the marriage are separate property and those accumulated after the date of marriage are community property. Regardless of state law characterization, federal law may give benefits to the non-employee spouse that are greater than community property rights.

What Happens To My Property at My Death?

Assuming you have a proper estate plan, your property will be distributed to the persons of your choosing. Texas does not require that you leave your separate property or your half of the community property to your spouse. You are thus free to leave it to whomever you choose. Keep in mind that a spouse has certain protections such as the right to live in the homestead for life, rent-free. There are family allowances that can also be claimed. These two items are beyond the scope of this article.

If you fail to have a plan, your state will make a plan for you. In that case, your community property will be divided a certain way while your separate property will be divided another way. In Texas, the division of community and separate property will depend upon whether you have children and whether the children are all the biological children of the deceased. This is one reason that it is imperative that you make a plan and put your wishes in writing. Otherwise, your heirs may or may not get what you would have wanted them to get.

What Happens to My Property If I Get Divorced?

With divorce rates over 50%, it is imperative that you know how your property will be divided. Texas law states that a court cannot award one spouse’s separate property to the other. All community property is fair game.

So what if one spouse has lots of separate property and the other spouse doesn’t? In that case the court has the authority to award an unequal proportion of the community property to the spouse that has relatively little separate property. The court will try to divide assets equitably keeping in mind that separate property of each spouse is off limits.

Can My Spouse and I Agree That Certain Property Is Separate or Community?

Yes. Many people with substantial assets will enter into written agreements concerning the parties’ property and debts. Separate property agreements, community property agreements, and prenuptial agreements are the primary mechanisms that are utilized. These documents are used to clarify the nature of the parties’ assets or to change the rules applicable to division of their property.

These agreements are flexible allowing the parties to express their wishes and desires. For example, the parties may agree that income from separate property will remain separate property. They can agree as to the disposition of property on separation, divorce, or death. The agreements can even waive homestead allowances, personal property set asides, and family allowances to which a spouse may otherwise be entitled.

How Does the Characterization of My Property Apply to Creditors of Either Spouse?

Generally speaking, the creditor of one spouse can only reach the guilty spouse’s separate property and his or her half of the community property. Under certain circumstances, the innocent spouse’s share of the community property may be reached, but only for claims of tortious liability.