Regardless of whether a couple living together is married or not, the issue of what belongs to one partner or the other is usually irrelevant in daily life. However, when death or break-up occurs, this topic suddenly becomes an issue of burning interest. It can yield some nasty surprises for the unprepared, especially when the one partner discovers that half of the property acquired during the relationship is now considered to be the property of the partner's former mate.
The determining factor in this situation is based on where the couple resides. Each state has its own property laws; some divide property according to common law statutes, while others consider the assets of couples to be community property. This article will examine the nature of common law and community property and what those differences mean when couples split up. (To read more about relationships and finances, see The Tax Benefits Of Having A Spouse and Marriage, Divorce And The Dotted Line.)
The concept of community property originates with Spanish law, and is found predominately in the Western states. As of 2008, the states that adhere to community property laws are California, Arizona, Washington, Wisconsin, New Mexico, Texas, Louisiana, Nevada and Idaho. All other states are considered common law states.
The community property statutes mandate that whatever property each partner brings into the marriage or relationship is their own, but anything acquired once the couple is living together is considered joint property. Each partner has a legal claim to half of this property, regardless of who actually acquired the property or how. Furthermore, any property owned by either individual before the relationship began also becomes community property if it is commingled with other community property during the relationship.
This law supersedes the titling of assets; an asset titled solely in one partner's name is still considered to be community property if it was earned or otherwise obtained during the marriage or relationship. However, federal pensions of any kind are generally excluded from this treatment. For example, any type of Social Security or railroad retirement benefit is considered to be individual property, regardless of state of residence, but private and military pensions are not eligible for this exclusion, and are therefore subject to community property regulations.
Common Law Property
Common law in America is derived from the laws of the United Kingdom, developed over centuries from thousands of disputes and court cases. In a common law state, any property that is titled in the name of one partner is that partner's property, regardless of how or when the property was acquired. When it comes to divorce, each partner has the right to claim a fair share of common law property; the higher earning partner is usually awarded two-thirds of the property, while the lower earning spouse gets the remaining third.
There are, however, a number of circumstances under which property belonging to one partner can be awarded to the other. One example is a qualified domestic relations order (QDRO), in which one spouse must distribute all or part of an IRA or retirement plan to the other. Ultimately, there are no absolute rules when it comes to dividing common law assets; the courts will usually allocate property according to various principles such as which spouse needs the property more, the duration of the marriage and other factors. (To learn more about QDROs, see Getting A Divorce? Understand the Rules Of Dividing Plan Assets.)
Tax and Estate Issues
The tax and estate treatment of common law property is fairly straightforward. All assets and income belonging to one spouse are treated as such in the event of death for estate tax purposes, but all income from either spouse is treated as joint income until then, provided the couple is legally married.
Income for cohabiting couples is reported separately. States that follow community property laws mandate that assets must be treated the same way at death as in divorce, regardless of whether the couple was married. Therefore, all community property is divided 50-50 with the surviving spouse or partner. The surviving partner retains his or her share of the property, while the property belonging to the deceased partner is included in his or her estate and subject to the terms of a will, probate or trust arrangements. (To learn more, check out our Estate Planning Basics tutorial.)
Extra Issues You May Encounter
In most cases, a couple's current resident state will determine the allocation of property, even if the property was originally acquired in a state with different laws. For example, property obtained by one partner in a common law state will be treated as community property if the couple now resides in a community property state. However, this rule does not apply to real estate, which is always governed by the laws in the state in which the real estate is located.
Gay couples may also have special considerations to deal with when it comes to dividing joint property. As of 2008, same-sex couples in California who marry are subject to the same community property laws as any other couple, but because this type of marriage is not recognized at the federal level, any type of retirement plan distribution stemming from a divorce is considered taxable income by the IRS. Whether California will recognize the same-sex unions of other states or countries and vice-versa is still unclear. Same-sex couples who move from a state that recognizes their union to a state that doesn't may also face a whole range of issues relating to their property.
Finally, prenuptial agreements may also supersede common and community property statutes in some cases. Most common law states will ultimately allow couples to do what they want with their property, as long as it's fair and both partners agree to the terms. (Keep reading on this subject in You Can't Live On Love and Create A Pain-Free Postnuptial Agreement.)
Common and community property laws can have complex legal, tax and estate ramifications that should be considered when combining joint property. Couples who are divorcing, separating or merely acquiring assets in a state with different laws than their own state of residence should seek guidance from an attorney or financial planner.