A common issue that arises when spouses divorce is whether a spouse’s inheritance can be considered community property. Although inheritances are generally considered a spouse’s separate property, there are circumstances in which a spouse’s inheritance can be considered community property. Those circumstances will be discussed throughout this article.
California is a community property state. According to California Family Code Section 760, community property is defined as “all property, real or personal, wherever situated, acquired by a married person during the marriage, while domiciled in the state.”
Generally, at the end of a divorce, community property is split equally (50/50) between the parties. However, prior to marriage, spouses can opt for entering into a prenuptial agreement that can dictate how their marital property is divided in the event of a divorce.
Alternatively, the California Family Code defines separate property as the following: (1) all property owned by a person before marriage; (2) all property acquired by a person after marriage by gift, bequest, devise, or descent; and (3) any rents, issues, or profits of a spouse’s separate property.
As such, a spouse’s inheritance is commonly considered his or her separate property and he or she will generally receive the entirety of their inheritance at divorce rather than having to split it with the other spouse, like the parties’ community property.
Although a spouse’s inheritance is generally considered his or her separate property, there are exceptions where a spouse’s separate property can be characterized as community property.
One exception is through a “transmutation.” A transmutation is a transaction between spouses where the character of one spouse’s personal or real property is changed in one of three ways:
1. From separate property to community property
2. From community property to separate property
3. From one spouse’s separate property to the other spouse’s separate property.
Pursuant to option (2), a spouse can transmute their separate property inheritance into a community property asset. In order for a valid transmutation to occur, the transmutation must be expressly made in writing and signed by the spouse who intends to transfer their property interest.
For example, if one spouse received an inheritance during the marriage, they could expressly transfer the inheritance, in writing, from their separate property to community property that they would then share with their spouse.
Another exception is through commingling a spouse’s inheritance with other community property. Commingling occurs when a spouse’s separate property is substantially mixed with community property.
For example, one spouse inherits $50,000 cash from their late mother and deposits the inheritance into a jointly owned checking account with their partner. Both parties have access to this checking account to pay bills, deposit their community earnings, pay for vacations, etc. Since both spouses use the checking account regularly, then the inheritance is considered commingled with the parties’ community property.
It is important to note that merely commingling a separate property inheritance with community property does not automatically convert the separate property inheritance into community property. In order for the separate property asset to be considered community property, the separate property asset needs to be so commingled with community property in such a way that the respective contributions cannot be traced or identified.
If the separate property contributions cannot be determined through a process called “tracing,” then the separate property inheritance will be treated as community property.
As mentioned, the mere commingling of separate property and community property does not alter the character of respective property interests if the components of the commingled assets can be traced to their separate property and community property sources.
Tracing is a method that is used to distinguish and prove whether funds in a particular account, or funds used toward a community asset, are separate property.
Tracing a separate property inheritance previously commingled with community property is important because it allows the inheriting spouse to identify what their separate property inheritance was used for so that they can be reimbursed for the entire inheritance at divorce.
There are two common types of tracing that are acceptable by the court to determine the character of disputed property. The two methods include (1) direct tracing and (2) the family expense (“recapitulation”) method.
Direct tracing involves using specific records (often bank statements) to reconstruct each separate property and community property deposit and each separate property and community property withdrawal, from the commingled account, as it occurs.
This process can be time consuming and often expensive, but it allows a spouse to provide proof of their separate property asset by documenting the balance of funds remaining in the commingled account after each expenditure throughout the relevant time period.
Alternatively, the family expense (“recapitulation”) method is a form of tracing that assumes all family living expenses and community debts are paid from community property funds. As a result, payments or a purchase can be traced to a separate property source by showing that community funds at the time of payment were exhausted from being spent on community expenses that the purchase had to have been made with separate property funds.
Essentially, the recapitulation method determines that separate property funds were used through the process of elimination with the assumption that community funds are used for all community expenses.
The process of tracing is important when a separate property inheritance is commingled with community property. Tracing allows the inheriting spouse to track their separate property inheritance so that they can prove that the inheritance remains separate property and they are entitled its entirety at divorce.
Although tracing can help a spouse receive their entire inheritance from a commingled account at the time of divorce, an inheriting spouse can save the time and expense that often accompanies tracing by keeping their inheritance entirely separate from any community property funds.
Money received from an inheritance will not be considered commingled or community property if the inherited money remains entirely separate from all community property.
For example, when one spouse receives an inheritance and deposits that money into a separate bank account, solely in their own name, and ensures no community money is deposited into that account, then the spouse prevents the inheritance from being commingled with any community funds. By doing so, the spouse will be entitled to the entirety of their inheritance without having to perform any tracing.
Although a spouse’s inheritance is generally considered their own separate property, there are exceptions where the inheritance can be characterized as community property. The commingling of a separate property inheritance with community property can make it difficult for a spouse to receive the entirety of their inheritance at divorce, but it is not impossible.
Tracing is an important and helpful tool that can allow an inheriting spouse to trace their previously commingled, separate property so that they will still be awarded the entire inheritance at divorce.
However, there is a possibility that a separate property inheritance becomes so commingled with community property that it is impossible to sufficiently trace what happened to the separate property. If that is the case, then a court will likely characterize the inheritance as community property.
If you inherited money and are now in the process of divorce, do not leave your inheritance to chance. Get expert help with your divorce case and let the experts assist you in tracing and advising you of your options so that you can start your next chapter with the entirety of your inheritance.