There are basically two types of property law in the United States.  One is common law property, which is based on British law, and the other is community property law, which is based on Spanish law.  Those states where the Spanish influence was strong tended to become community property law states.  The states are: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.  (I know Louisiana is based on French law, but somehow it got in on the community property gig.)  Alaska and Tennessee have adopted an optional community property law.  Puerto Rico and some Native American tribes have community property type laws.

There are some estate tax/income tax advantages to community property law, but there are also some significant asset protection disadvantages.  In community property jurisdictions, each spouse is considered to own an equal interest in all marital property.  The two spouses are basically considered one economic unit.  In common law property states, each spouse is a separate entity.  They can own property independent of any interest in the other spouse.

In community property states, because the property can’t be “separately” owned, the property is exposed to the liabilities and creditors of both spouses.  Thus, one of the simplest asset protection moves available to a couple is not available in community property states.  On the other hand, in common law states, the husband can own property and the wife can own property.  Ownership of the property can be separated.  The property owned by the husband isn’t available to satisfy the debts and liabilities of the wife, and property owned by the wife isn’t available to satisfy the debts and liabilities of the husband.  Separating ownership of family assets between a husband and wife is a simple asset protection technique that can be used in common law states.

It isn’t unusual for a doctor, CPA, contractor, or professional that carries a liability exposure to put ownership of family assets (house, bank accounts, etc.) in the name of their spouse.  Ideally, a living revocable trust should be used so that when the spouse dies, the family doesn’t have to probate his or her assets.  In common law property states, separating ownership of assets between a husband and wife is simple and fast asset protection.  But, couples in community property states can’t do it, because what’s his is hers and vise versa.

It should be noted that most couples in common law property states don’t take advantage of this simple and fast asset protection.  They simply own assets jointly.

Assets brought into the marriage or received by one spouse through inheritance or gift can be maintained as “separate” property even in a community property state.  However, there has to be steps taken not to permit the assets to be commingled and become community property by default.

The advantage to community property occurs at death.  All assets get a step-up in basis at the death of the first spouse to die.  In common law states, only property owned by the deceased spouse or half of the jointly owned property gets a step up in basis.  This becomes significant, because when property is sold after the death of the first spouse to die, there won’t be any income tax, if the property is sold at the value it had on the date of the spouse’s death.  So being in a community property state could save you some income taxes after your spouse dies.

The short story is there are asset protection advantages to living in a common law property state, and there are income tax advantages to living in a community property law state.  But to get the tax advantages, one of the two spouses in a couple have to die.  I personally lean toward the asset protection advantages, but community property vs. common law isn’t a big reason for picking a state to live in.

  1. Which steps have to be taken to prevent the assets from being commingled and become community property by default?

  2. SLW,
    In order for an asset to be separate property it must be an asset that was acquired before the marriage or an inheritance during the marriage. That asset then must remain in the sole name of the spouse for whom it is separate property. You can’t put money into a joint bank account or have both spouses names on a deed, otherwise it becomes marital property. The asset can be sold but the proceeds must still remain in an account that is soley owned by the spouse for whom it is separate property. As long as there is a paper trail showing that assets have been bought or sold from separate property, the new assets will remain separate property. If you buy something with both separate money and marital money, then the new asset will be marital property.

  3. I live in Tennessee and just found out yesterday that my name isn’t on the deed. If I leave and divorce what rights do I have ?

Leave a Reply