Texas Community Property Law and How to Plan…

Jack Bux and his high school sweetheart, Diane, have been married a few years, but the pandemic has taken its toll on their relationship, and they could soon be parting ways. Going into the marriage, Jack had a number of property interests – a home with a mortgage, a retirement account and a small part of the family business – and now he’s concerned that Diane will be able to walk away with half of what he’s been building over the years. Like most Texans, Jack is aware that when it comes to marital property, Texas is a “community property state.” What does this really mean for Jack’s home, retirement account and business?

The answers to these questions depends on the type of property involved, when it was acquired and any agreements the parties have about the property that might alter the default community property regime.

Marital property in Texas is deceptively simple. Property owned by any spouse falls into one of two categories: separate or community. Separate property is anything owned prior to marriage or received through either gift or inheritance during the course of the marriage. Community property is everything else. Accordingly, any marriage has three estates: a community estate belonging to both and each party’s separate estate – yours, mine and ours. At the time of divorce, the community estate is the only property subject to division, and that property simply has to be divided in a “just and right” manner. So generally, community property is everything that the parties accrue over the course of a marriage, and it has to be divided fairly – not necessarily 50/50 at the time of divorce.

While this may seem straightforward at first blush, countless real-world issues arise when valuing estates in a divorce and distinguishing community property from separate. Let’s discuss some of the issues that our characters Jack and Diane are likely to run into:

Property Owned Prior to Marriage but Paid Off During the Marriage

Like Jack, many people come into a marriage owning a home or vehicle that they purchased prior to the marriage. Because of the inception of title rule, which says that a piece of property retains the original character (that is, separate or community) that it had at the time of purchase, any property purchased before marriage will remain separate property. HOWEVER, debts on separate property that are paid down during a marriage create a reimbursement claim against the separate property.

So with Jack’s home purchased before marriage and paid down during the marriage using community property (income earned during the marriage), the community estate will be able to effectively “reclaim” the pay-down of principal on the mortgage, thereby giving Diane, the non-homeowner spouse, an opportunity to recoup some of the value that accrued to the house during the marriage. Even if Diane’s name is never on the title to the house, she can recover these funds. One caveat especially true in this hot housing market: any gains in the value of the property itself due to factors outside of the parties’ control remain to the benefit of the separate property. So Diane will include the value paid toward principal on Jack’s mortgage as part of a “reimbursement” claim by the community against Jack’s separate estate, as Jack’s separate property house increased in net value when the community paid off his mortgage.

Retirement Account Started Before Marriage with Contributions During Marriage

Like plenty of people, Jack also entered into marriage with a retirement account. Again, the inception of title rule allows Jack, the account holder, to keep the account as separate property. But similar to the pay-down of his mortgage, when community funds are deposited into the retirement account, the community will have an interest in the account. To add further complexity, any given retirement or brokerage account will typically increase in value through a combination of deposits, interest, increase in value of its component holdings and dividends. For Jack’s retirement account that he started before marriage but held and contributed to during marriage, each of these components can have either separate or community implications. Therefore Jack will likely need a forensic “tracing” of his retirement account to prove how much of the account is his separate property. Otherwise, the community interest in the account will be all the gains on that account during the course of the marriage, which is in all likelihood an over-valuation of the community’s true interest.

Business Owned Before Marriage

Similar to the previous illustrations, interest in a business owned before a marriage can retain its character as separate property. That said, any number of events that might happen during the marriage will complicate that. For instance, Jack may have from time to time capitalized the business with outside funds. To the extent that has happened, those funds, and Jack’s related share in the business, could be subject to a reimbursement claim by the community estate. Likewise, Jack’s efforts during the marriage to increase the value of the business are also subject to a possible community reimbursement claim. Or, as a final example, Jack may have an agreement with the business that he will acquire shares of the business under a vesting schedule, which might create an unclear picture due to partially-vested shares at the time of divorce. Any of these could create the need for a forensic accountant, or at a minimum, experienced family law attorneys to assist Jack and Diane in valuation and division.

Tilting the Scales in Your Favor

Texas community and separate property laws can be complex, with unexpected traps for the unwary. Finally, do not assume that, in the event of divorce, community property will simply be “divided down the middle” or given to the person in whose name it is titled, as numerous factors can add complexity to the overall valuation and division of marital property.

In our next post, we’ll discuss how before entering into a marriage, potential spouses can eliminate many of the uncertainties that can, and often does, come with an “out of the box” community property arrangement by having an experienced professional draft a premarital agreement to simplify how property will be divided in the event of divorce.

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