Understanding the Distinction Between Community and Separate Property

Texas is one of nine states that are considered “community property” states, meaning generally that property acquired during the marriage is considered owned equally by both spouses. The other states that are considered community property states are:

--Arizona
--California
--Idaho
--Louisiana
--Nevada
--New Mexico
--Washington
--Wisconsin

In Texas, all property (including cash) is classified as community or separate based on when and how it was acquired. Texas (as does some other states) has what is known as the “Inception of Title” rule, which basically states that the characterization of the property is determined at the time the property is acquired. Further, all property acquired during a marriage in Texas is presumed to be community property unless it can proven otherwise.

Converting an asset into cash and back again does not affect the classification. For example, if a separate property asset, such as real estate, is sold during the marriage, the proceeds of that sale and anything purchased with the proceeds will remain separate property. However, you must be able to "trace" the proceeds from each sale to each purchase to prove that the property is separate property. Unless you keep excellent records, this can be difficult.

Under the Texas Family Code, community property is actually negatively defined. That is, Section 3.001 of the Family Code defines what separate property is, and then Section 3.002 states that community property is any property acquired by either spouse during the marriage that isn't separate property.

Separate property (under the Family Code) is defined as follows:

1. Property owned or claimed by the spouse before marriage;
2. Property acquired during the marriage by gift, devise or inheritance; and
3. The recovery for personal injuries sustained by a spouse during the marriage (but not any recovery for loss of earning capacity, which is considered community)

Thus, some examples of separate property might be:

1. Earned income from the work of either spouse before the marriage.
2. Capital gains on separate property (e.g., Joe buys 100 shares of ExxonMobil stock before he marries Sue at $50/share, and after his marriage, the stock goes up to $75/share. The increase in the value of the stock is still considered separate property);
3. Gifts and inheritances received by either spouse during the marriage, including joint gifts (e.g., if Dad gives Son and Son’s wife a piece of real property worth $100,000, Son and Son’s wife each have a 50% separate property interest in the property). Likewise, if Dad dies and leaves that same property to Son and Son’s Wife, the same is true—Son and Son’s wife each have a 50% separate property ownership in the property).

Since, by definition, everything else acquired during the marriage is community property, that means that anything other than the above ought to be classified as such. As you can probably guess, it usually is never quite that simple. However, some examples of community property are as follows:

1. Earned income from the work of either spouse during the marriage.
2. Dividends, interest, and capital gain earned on community property.
3. Dividends and interest earned on either spouse's separate property during the marriage.

Notice that last one? The rule in Texas is that income from separate property is considered community property, and the only way to get around that is to have an agreement in writing. Texas Family Code Section 4.103 allows a couple to agree that the income from separate property will remain separate. The agreement must be in writing and signed by both parties.

A couple can turn community property into separate property by executing a partition or exchange agreement. It must be in writing and signed by both parties. The one thing to note if you execute this type of agreement is that the income and earnings from the separate property will now remain separate unless you actually agree in the partition that the income will continue to be community property.

It used to be the law that you could not create community property out of separate property, but ever since January 1, 2000, a couple can now agree in writing that separate property of one spouse can be converted into community. The writing has to be very specific about what is being converted, and that it is being converted to community property. Further, there can be no consideration for entering into the agreement. That is, it has to be totally voluntary on the part of both spouses, and it is considered a gift by the one spouse who owned the separate property to the spouse who is receiving the new community property interest. Section 4.205 of the Family Code provides disclosure language that must be contained within the agreement to provide for a rebuttable presumption that the agreement was fair and reasonable.

The distinction between separate and community property is a very important one, especially when a couple divorce, because the Texas Constitution and codified law provides that no separate property of one spouse can be awarded by a judge to the other spouse in the division of assets. The identification of an asset as separate or community is also important on a person’s death, especially if the person did not have a Will. Separate and community property pass by intestacy differently, as I discussed in a previous post.

It would be helpful, as part of your estate planning, to make sure you can easily identify which of your assets are separate and which are community. If you have difficulty in doing so, you should confer with your accountant or attorney about how to trace those assets back to their origin. Doing so may be of some benefit to you in the future.