What You Need to Know If You Live in a Community Property State
Most states are “common law states,” which means married couples may share many aspects of their lives, but their property is individually owned unless both of their names are on a contract. Things work differently in community property states, where assets and liabilities that either person acquires during the marriage become the joint property of both spouses. In other words, “what’s mine is yours” legally applies to all sorts of income and debts.
Generally, community property laws become important during a divorce and for estate planning purposes. They can impact how a judge will split up the property that’s been acquired since you got married. Or, which property you can pass on in your will.
Which States Have Community Property Laws?
There are nine community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.
Additionally, couples in Alaska can choose to use community property laws, while those in South Dakota and Tennessee can create a trust and move assets into the trust if they want them to be jointly owned.
What Counts as Community Property?
If your primary residence is in one of those states, then most assets acquired by either spouse during the marriage are treated as community property. Property can refer to physical possessions and intangible assets, including:
In essence, the state views your marriage unit as a single entity, a bit like a business partnership. For example, any wages you earn are equally owned by you and your spouse, even if the money goes into an account that only has your name on it (rather than a joint account).
Similarly, both spouses owe the debts taken on by either spouse, even if only one of them takes out the loan or uses a credit card. Although, there may be some exceptions if the debt isn’t taken on for a purpose that benefits both spouses in some way.
When a married couple moves into a community property state, the property they’ve acquired since getting married but before the move may be called quasi-community property or community-like property. Although it may have been separate property when it was acquired, it could still be treated as community property by the state where they now live.
Exceptions to Community Property
Even if you live in a community property state, you may still retain some of your property as separate property—meaning you’re the sole owner.
Separate property generally includes everything you owned before you got married, along with gifts and inheritance that are only given to you during the marriage. It can also include debts you took on before the marriage, such as student loans.
When you buy something with your separate property, the distinction can also carry over. For example, if you use separate property savings to purchase a rental property or an inheritance to buy a vehicle, those may remain separate property as well.
Sometimes, separate property gets mixed with community property, which is referred to as commingling. For example, you may inherit money (separate property), but then deposit it into a joint account where it becomes community property. Or, you could have a retirement account that has a balance in it when you’re married (separate property), but then contribute to it after your marriage with income that’s community property.
You may be able to separate commingled property later. During a divorce, you could hire a financial advisor to determine how much of a retirement account’s balance is due to the separate versus community property, for example. However, there are also times that funds get mixed together so much that the entire account or property becomes community property.
During a divorce, community property may be split 50-50 between both parties. However, if you can agree to an equitable split, you don’t necessarily need to divide all community property in half. For example, rather than dealing with the tax consequences of withdrawing money from a 401(k) early, perhaps you get to keep all the 401(k) funds and your former spouse gets to keep the house.
Community Property and Taxes
In addition to divorce and estate planning, community property laws can also impact your annual tax return if you use the married filing separately tax return status.
Because you own half of the community property, along with your separate property, you’ll have to include all that income on your tax return. You’ll also receive half of the tax deductions and credits to determine how much you owe or how big of a refund you’ll receive.
You’ll need to follow the rules even if you’re separated but still legally married and at least one person lives in a community property state. As a result, you might have to add or subtract income from your tax return, or even if you don’t share any money with the other person. But there are also exceptions, such as when you didn’t live together for the entire year and didn’t transfer the community property between each other.
Protecting Yourself From Future Conflict
If you’re worried about community property becoming an issue after you’re married, you could write up and sign a prenuptial agreement that overrides the state’s default community property laws.
For example, the prenup may explicitly state that both party’s earnings, assets, and debts remain separate property. Or, it could be more explicit about a particular situation, such as designating one person’s business and business income as separate property, but allowing everything else to become community property.
If you’re already married, you could also draft and sign a postnuptial agreement that covers many of the same things. These can be particularly helpful if you get married in a common law state and are moving to a community property state. With both pre and postnuptial agreements, state laws may limit what you can include in, and you’ll want to work with an attorney who is familiar with the specific state’s laws.