Our latest blog post explores what is the difference between community property and separate property in California.
If you are married and live in California, you have probably heard the terms community property and separate property. But many married couples are not entirely sure what those terms mean—or why the distinction matters.
The characterization of property as community or separate can affect who owns the property during marriage, what happens to it during divorce or after the death of a spouse, how it should be handled in a living trust, and even the potential tax consequences after death.
For married couples working with a Carmel Valley estate planning attorney or a trust attorney in San Diego, identifying which assets are community property and which are separate property is an important part of creating an estate plan.
What Is Community Property in California?
California is a community property state.
As a general rule, property acquired by either spouse during marriage while domiciled in California is community property. California Family Code Section 760 establishes the general presumption that property acquired during marriage is community property.
In practical terms, the community property commonly includes:
- Income earned by either spouse during the marriage;
- A home purchased during the marriage with marital earnings;
- Bank and investment accounts funded with earnings during the marriage; and
- Other assets accumulated with community funds.
It generally does not matter which spouse earned more money or whose paycheck was used to purchase an asset. Community property generally belongs equally to both spouses.
For example, suppose a married couple purchases a home in Carmel Valley using income earned during their marriage. Even if one spouse earned most of the money used to purchase the home, the property is going to be characterized as community property.
What Is Separate Property in California?
Separate property generally belongs to only one spouse.
Under California Family Code Section 770, separate property generally includes:
- Property owned by a spouse before marriage;
- Property received by one spouse as a gift solely to them during marriage;
- Property inherited by one spouse during marriage; and
- The rents, issues, and profits generated by that spouse’s separate property.
For example, if a wife inherits $500,000 from her parents during her marriage, that inheritance is generally her separate property.
Similarly, if a husband owned a rental property before getting married, that property generally begins the marriage as his separate property.
However, the analysis does not always end there.
Separate Property Can Become More Complicated During Marriage
One of the most common misconceptions is that property will necessarily remain separate simply because it started out that way.
How property is handled during the marriage can matter.
For example, separate and community funds may become mixed together, commonly referred to as commingling. Community funds may also be used toward an asset that began as separate property. For example, if the couple in the example above did not have a premarital agreement and the husband pays the mortgage loan on the separate rental property with community property funds, a reimbursable community property interest will be created in the rental property.
In other situations, spouses may intentionally change the characterization of property.
California refers to an agreement or transfer changing the characterization of property between spouses as a transmutation. For transmutations made on or after January 1, 1985, California generally requires a writing containing an express declaration by the spouse whose interest is adversely affected.
Because of these rules, determining whether an asset is community or separate property can sometimes require looking beyond whose name appears on an account or deed.
Does Putting Property Into a Living Trust Change It From Separate to Community Property?
Not necessarily.
This is an important issue when creating a revocable living trust for a married couple.
A living trust is primarily an estate planning vehicle. Simply transferring assets into a joint living trust does not mean that every asset will automatically be treated as community property.
A properly drafted trust will generally identify and preserve the character of the couple’s assets but will not change it. For example, the trust may hold:
- The spouses’ community property;
- The husband’s separate property;
- The wife’s separate property; or
- A combination of all three.
This is one reason asset characterization should be addressed when a married couple establishes or updates a living trust.
A San Diego estate planning attorney should discuss not only which assets will be transferred into the trust, but also how those assets are currently characterized and how the spouses intend them to be characterized in the future.
Why Does Community Property Status Matter at Death?
Property characterization becomes particularly important when one spouse dies.
Each spouse generally owns a one-half interest in community property. By contrast, separate property belongs entirely to the spouse who owns it.
That distinction can affect what the deceased spouse can transfer through an estate plan and what continues to belong to the surviving spouse.
For example, if a married couple owns a $2 million investment account as community property, each spouse generally owns a one-half community property interest.
If instead the entire account is one spouse’s separate property, the ownership analysis is very different.
A well-drafted estate plan should account for these distinctions rather than treating every asset owned by a married couple as though it were the same.
Community Property Can Also Have Important Tax Benefits
Community property characterization can have significant federal income tax consequences after the death of a spouse.
Under Internal Revenue Code Section 1014, certain property receives an adjustment in income tax basis at death.
For qualifying community property, when one spouse dies, both the deceased spouse’s one-half interest and the surviving spouse’s one-half interest generally receive an adjustment in basis to fair market value. The IRS specifically recognizes this treatment for qualifying community property.
This can make an enormous difference when appreciated assets are later sold.
For example, assume a married couple purchased a California home many years ago for $400,000 and the property is worth $2 million when the first spouse dies.
If the property qualifies for the community property basis rules, the basis of the entire property may generally be adjusted to its $2 million fair market value at the first spouse’s death.
By comparison, property held in another form of joint ownership may receive a basis adjustment only with respect to the deceased owner’s interest. The IRS illustrates this distinction when discussing jointly owned homes and community property.
This is one reason married California homeowners should understand how their property is titled and characterized.
Community Property and Joint Tenancy Are Not the Same Thing
Another common source of confusion is the assumption that property owned jointly by spouses must be community property.
That is not necessarily true.
Joint tenancy is a form of title. Community property describes the marital character of property.
The distinction can be particularly important for appreciated real estate because the federal basis rules applicable at the death of a spouse can differ depending on whether the property qualifies as community property.
California married couples reviewing an older estate plan should therefore look at how their real property is currently titled rather than assuming that ownership by both spouses automatically means that the property is community property.
What About Property Acquired Before Marriage?
Property owned before marriage generally starts as separate property.
But what happens afterward can matter.
Suppose one spouse purchases a house before marriage and continues to own it after getting married. The house does not automatically become community property simply because the owner gets married.
However, the analysis may become more complicated if community funds are subsequently used toward the property, the spouses change title, or they enter into an agreement changing its characterization.
This is one area where the facts surrounding the acquisition and subsequent handling of the property can be particularly important.
What About an Inheritance Received During Marriage?
An inheritance received by one spouse is generally that spouse’s separate property, even if the inheritance is received during the marriage.
The same general rule applies to a gift made specifically to one spouse.
For estate planning purposes, however, the spouse receiving the inheritance should consider how the inherited property is subsequently titled and maintained.
For example, keeping inherited funds in an identifiable separate account may make their separate-property character much easier to establish than depositing the inheritance into an account containing substantial community funds. That’s why a lot of time we will establish a separate property trust to hold and manage the inherited property separately from other assets owned by a married couple.
Can Spouses Choose to Change Separate Property Into Community Property?
Yes, subject to California’s requirements.
Spouses sometimes intentionally convert separate property into community property as part of their broader financial or estate planning.
They may also decide to convert community property into separate property.
These decisions should be made carefully. Changing the characterization of property can affect ownership rights, rights at death, divorce consequences, creditor issues, and potential tax treatment.
A transfer that appears simple on paper can therefore have consequences well beyond the estate plan itself.
Why Property Characterization Matters When Creating a Living Trust
When I prepare a living trust for a married couple, the objective is not simply to place names and assets into a trust document.
The estate plan should reflect who actually owns the property and how the couple wants that property treated.
That can require identifying:
- Community property;
- Each spouse’s separate property;
- Property whose characterization may be unclear; and
- Property the spouses intentionally want to recharacterize.
These distinctions can then be reflected in the trust documents and, where appropriate, in the way assets are titled.
This becomes especially important when spouses have children from prior relationships, significant premarital assets, inherited property, investment real estate, business interests, or substantially different contributions to their accumulated wealth.
Community Property Planning for San Diego Married Couples
California’s community property system can provide important estate planning and tax opportunities, but those benefits depend in part on understanding how property is actually owned.
A deed, account title, inheritance, premarital asset, or transfer between spouses can raise issues that are easy to overlook when preparing an estate plan.
For married couples in Carmel Valley, Del Mar, La Jolla, Rancho Peñasquitos, and throughout San Diego, reviewing property characterization should therefore be part of the estate planning process—not something considered only after a spouse dies or a problem arises.
If you are creating or updating a living trust, a Carmel Valley estate planning attorney or trust attorney in San Diego can help you review how your assets are currently titled, determine how they should be addressed in your estate plan, and prepare a trust that reflects your intended ownership and distribution of your property.
Law Office of Milda Goeriz assists individuals and families with living trusts and estate planning throughout San Diego, including Carmel Valley, Del Mar, La Jolla, Sorrento Valley, Rancho Peñasquitos, Mira Mesa, and surrounding communities.