Converting Community Property into Separate Property

Updated: Sep 27, 2021


Dear Mr. Premack: My wife and I have different opinions on disposition of our properties. Can you outline the procedures we should follow in order to take our community property and fairly convert it into separate property? In that manner, we each can make dispositions as we see fit. -- L.F.


In Texas, all property acquired during marriage is community property except for 1) the things you owned before marriage, 2) items you received during marriage as a gift or inheritance, and 3) items that are partitioned between spouses by written agreement. Those items are separate property.


The Texas Family Code allows you and your wife, in a written partition agreement signed by both of you, to convert some or all of your community property into separate property. You may record the agreement with the County Clerk, a practice I strongly encourage when the partition involves real estate.


A partition may be done at any time during a marriage. In some ways, it is akin to a prenuptial agreement but is done after the marriage commences. The partition agreement can include property which is currently community and property which might become community in the future. For instance, a separate property bank account may earn interest. By law, that interest is community property, which causes a steady commingling between that separate property and new community property.


The solution is for the partition agreement to state that earnings created by separate property retain their separate property identity. In that manner, commingling is avoided.


A partition agreement (or a prenuptial agreement, depending on the timing) is only valid under Texas law if it does not "defraud" the creditors of either spouse. You must each have adequate resources to pay your debts after agreement is signed.


Further, either spouse may later challenge the validity of the agreement by proving that: a) the agreement was not signed voluntarily, or b) the agreement was unconscionable when it was signed because the challenger did not know about and was not provided with a fair and reasonable disclosure of the assets and debts of the other spouse.


Note also that community property is given more favorable tax treatment at the time of inheritance. Assume you own 1000 community property shares of Tesla stock which you purchased for $100/share but is now worth $700/share. If it a) stays community property and b) one spouse dies, and c) the surviving spouse sells, gain tax is forgiven on the entire value. But if a) the stock is converted half as husband’s separate property and half as wife’s separate property, b) one spouse dies, and c) the inheritor sells, taxes are forgiven only on the inherited half but are not forgiven on the other separate property half. It could cost in the ballpark of $60,000 in otherwise avoidable gain tax.


You should hire an attorney to review your overall estate plan. There may be ways for you to accomplish your distribution goals without the need to partition assets into separate property.

 

Column published on August 2, 2021.


Paul Premack is a Certified Elder Law Attorney for Wills and Trusts, Probate, and Elder Law issues. He is licensed to practice law in Texas and Washington. To contact us, click here.