Separate vs. Community Property
Question: A number of years ago, my husband inherited quite a large sum of money from his family. He purchased a house, paying cash, and invested the balance in various ways. He has kept the house and the entire inheritance in his name only. All the forms of investment have increased very much in value. The house alone has increased threefold. I realize that his inheritance is his alone, but what about the increased value of his inheritance? Is that increase his alone, or is it considered to be community property?
My husband has placed his entire inheritance in a living trust for his two children by a former marriage. If any of the increased value of his inheritance is community property, how does the living trust affect this? We live on our combined incomes, and he has gone into a personal bank account on occasions to handle emergencies. Otherwise, our combined income covers everything. I hope you can answer.--S.N.
Answer: This is a very confusing area of law, but there are a few basic principles, and it sounds as if your husband followed them well enough to keep all of the inheritance as his alone. An inheritance, even one received during a marriage, is considered separate property. It is owned by the recipient, who is free to do whatever he or she wants to do with it, and the spouse has no right to share in it.
On the other hand, earnings from work during a marriage are considered community property, jointly owned by husband and wife.
The general rule is that separate property remains separate property, and the interest and growth from the property remain separate, but there are a host of exceptions and permutations. For example, if your husband had taken the separate property and invested it in a family business, and if that business increased in value, then you might have a claim that some of the growth is community property because it is the result of your husband’s services in improving the fortunes of the business. Still, the separate property would be entitled to a “reasonable investment return,” so a judge would have to decide how much of the family business is separate property and how much is community property.
If a person takes separate property and buys a house, paying cash, the increase in value will generally remain as separate property. This is, in part, because the increase in value has nothing to do with that person’s work or services. The increase in value of a house in Southern California, notes estate-planning lawyer John R. Cohan, “doesn’t take any work, it just happens.”
The case would be much more complicated if the husband had invested a portion of his separate property as the down payment but then paid the mortgage with community property earnings. In that case, a judge (either after the death of the husband or a divorce) would have to determine what portion of the house is owned by the community and what is owned separately. It would, in another words, be a legal mess.
Another messy situation occurs when a person commingles his or her separate property with community funds. It is possible to trace the funds, to determine that some or all remain separate and were not gifts to the community, but the legal burden is on the person who claims that the property is separate. (That’s why the husband’s decision to place his separate property in a trust for the benefit of his two children was a smart move; it helps maintain its clear separate nature.)
The only other claim a wife could possibly assert in this example, Cohan notes, is to say that in making the investments, the husband was “working” as a professional investor, and the community should derive some benefit from his labor. But even if this argument was successful, and it’s not clear it would be, this compensation would probably not be in the form of a percentage of the increase in value in his portfolio, but some small standard fee, and since some of the husband’s separate monies were used in emergencies, the community may have already been paid.
