It’s true; Baby Boomers’ parents have been known to build up a sizable nest egg over the last 50 years and leave gifts and inheritances to their children, but do Boomers’ really understand what this means if you are married?
The answer: if you are married, gifts and inheritance are considered separate property in the State of California. Often times, people wonder whether or not they need a pre-nuptial or post-nuptial agreement when they receive significant gifts or inheritances to make sure it
does not become community property. This subject should always include a family law attorney however it is an essential part of any estate plan as well.
Generally speaking, if property (cash, stocks, bonds, real estate, etc.) is received as a gift or an inheritance, it is not considered community property. As long as it is not commingled or does not have debt or a mortgage attached to it that is paid with community property
income. Property with a debt or mortgage, that has negative cash flow (if paid with community property earnings), can have a little piece of the separate property converted to community property when each community property payment is made. This is common when a
rental property is inherited by one spouse, and the rents are not enough to cover all of the expenses, and a husband’s and wife’s community property earnings are used to pay for the negative cash flow.
In order for separate property of one spouse to be converted to community property of both spouses, it must be the subject of a “transmutation agreement” (an agreement that is agreed to and signed by the spouse that wants to convert his or her separate property to
Don’t be fooled though – separate property has its own unique income tax issues. Unlike Community Property (which receives 100% “step-up in tax basis”*** when a spouse dies), the separate property of the surviving spouse does NOT receive a *”step-up in tax basis” upon the death of his or her spouse. The subject of a spouse that is willing to transfer separate property to community property, is essentially a decision to give away half of his or her separate property to his or her spouse, which would have far greater economic
consequences, if a divorce (“dissolution of marriage” in California) occurs later down the line.
Separate Property is something that is often misunderstood. Make sure you retain suitable legal counsel when considering these issues.
***(See April 26, 2013 Blog on “Step-up in Basis)