How Do Community Property and Separate Property Rules Effect a Divorce

In United States there are currently nine community property states. These include Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. In its most simplistic form, community property is a state statute that mandates concurrent form of ownership between husband and wife. In community property states the earnings of the husband and wife are considered community property and thus are equally divided between the spouses during marriage. Any assets that are purchased during marriage with community property funds remain community property marital assets. Separate property can consist of property that was acquired before marriage, property that’s inherited during marriage, or property that’s received via gift during marriage. Separate property of each spouse even words brought into a community property state remain separate property provided that the property has kept segregated,’s not commingled with community property assets and thus is separately identifiable. And income generated by a separate property asset is separate property income and belongs to the spouse that owns the separate property.

Under California Family Code 125, California divorce can treat property that is acquired in a common law state as community property if the property would have been considered community property had it been acquired in California instead of out of state. Separate property in California also includes—where separate property is sold and new property is acquired. If the proceeds or traceable to the sale of separate property and that asset isn’t commingled with the community property asset it remains separate property.

Any property that is inherited during marriage is separate property but if it’s commingled with a community property asset it may lose its distinction as separate property and become community property in situations where it’s not separately identifiable. In California it’s important to think about the fact that separate property can be improved with either community property assets or community property labor. When this occurs it may be necessary for an allocation of value to be given back to the community property estate before they split in the divorce.

Where this comes up a lot is where a separate property business is owned before marriage. Even though the business is a separate property business one spouse own the entire business before they got married. The entire time that they are improving the value of that business through their own labor that labor’s community property asset and the marital estate is do an allocation of value for the improvement in that business over the course of the marriage.

Again the labor of a spouse that improves the value of a business during marriage is a community property asset. For this reason if a business predates a marriage it is very likely that this will require both a separate property allocation of value and a community property allocation of value. The allocation between separate property and community property value depends on several factors. The factors considered to make this allocation include the following: How long before marriage was the business started? What was the company’s fair market value at marriage and its history of profitability before and up to marriage? What was the businesses average cash flow both before marriage and during marriage?

Here’s a really tricky one, of the increase in value during marriage how much of that can be attributed to the community property efforts of one spouse versus the separate property value that was contributed at the beginning of the marriage? Was there additional separate property invested in the business during marriage? Was there additional community property income that was invested during the marriage? What are the market conditions both when they got married, over the course of the marriage and at divorce? Community property laws may be relevant even in common law states. For instance if property is acquired in a community property state and then later taken into a common law state it retains its character as community property for both divorce purposes in the common law state and for income tax purposes.