October 23, 2014

Community Property and Separate Property Trusts

California is a community property state for marital property purposes. This means that assets considered "community property" are equally owned by the spouses, i.e. each owns 50%. Conversely, assets considered "separate property" are owned 100% by the acquiring spouse.

Occasionally a married prospective client will call and ask about writing a trust for solely themselves. The crux is that while community property results in equal ownership, it does not allow for unilateral disposition unless one spouse is giving it to the other spouse. Smedberg v. Bevilockway, 7 Cal. App. 2d 578, 582 (1935). Simply stated, community property is considered indivisible.

The logical follow-up to this dilemma is to determine what is considered community and what is considered separate property. 

Ahhh, if only life was that easy. 

Determining the characterization of an asset is a labor-intensive chore. It is not as simple as saying if acquired during marriage such is community property or if acquired before marriage such is separate property. Rather, the date of acquisition, the manner of acquisition, the sources of funds of the acquisition, etc. needs to be ascertained to properly characterize the asset. 

Some might say that a transmutation agreement can eliminate the property characterization process because community and separate property can be definitively distilled into an agreement. See Family  Code § 850. That is, in a transmutation agreement the parties can agree to change the characterization of property from separate to community or vice versa. So if the parties have doubt about an asset being community or separate property because of a lack of documentation, they can agree in writing to alter the characterization to eliminate any doubt. However, a transmutation agreement will require the consent and understanding of both parties. Hence, a spouse wanting to do a trust unilaterally will still need the involvement of the other spouse if a transmutation agreement is sought. 

Furthermore, a transmutation agreement can be a legal quagmire if not properly completed. For example, an ex-wife incurred $120,000 in attorney fees to determine the validity of a transmutation agreement. The ex-wife and her ex-husband executed a transmutation agreement with a prominent law firm in San Jose. The transmutation agreement gave the ex-wife a community property interest in the ex-husband's previous separate property business interests. During the divorce proceeding, it was invalidated on the grounds that the ex-husband did not understand the full legal consequences of the agreement. Whoops. The ex-wife sued the law firm for malpractice but her complaint was dismissed for failure to timely file, i..e outside the statute of limitations.  All in all, a complete legal disaster.

Ultimately if a married person is seeking to do a trust unilaterally, they will find few, if any, attorneys willing to take the case given the consequences.