Community Property

Community property is a legal framework governing marital assets that treats a married couple as a single economic unit. Think of it as a “we're in this together” approach to your finances. In jurisdictions that follow this system—including several U.S. states like California, Texas, and Arizona, as well as countries like France and Spain—most property acquired by either spouse during the marriage is considered jointly owned. This means it belongs to both partners in equal 50/50 shares, regardless of whose paycheck bought it or whose name is on the title. This concept of shared ownership is a cornerstone of family law in these areas and has profound implications for an investor's portfolio, especially when it comes to major life events like divorce, death, and managing debt. It is crucial to distinguish community property from “separate property,” which typically includes assets owned before the marriage, as well as individual gifts and inheritances received by one spouse during the marriage.

Understanding what falls into the “community” pot is key. While the specifics can vary slightly by jurisdiction, the general rules are quite consistent.

This generally includes almost everything of value earned or acquired during the marriage.

• Earnings: Salaries, wages, bonuses, and commissions earned by either spouse.
• Investment Income: Dividends, interest, and capital gains generated from community assets. If you buy a stock with your salary, that stock and its earnings are community property.
• Assets Purchased with Community Funds: A house, car, or investment portfolio bought with money earned during the marriage.

This is property that belongs solely to one spouse.

• Pre-Marital Assets: Anything you owned before you got married.
• Gifts and Inheritances: Items or money given specifically to one spouse, even if received during the marriage.
• Personal Injury Awards: Compensation for pain and suffering is typically separate, though compensation for lost wages might be considered community property.

Here's where it gets tricky. If you “commingle,” or mix, your separate property with community property, it can lose its separate character. For example, if you deposit a $50,000 inheritance (separate property) into a joint checking account that you and your spouse use for daily expenses (community funds), a court might later rule that the entire inheritance has become community property. Meticulous record-keeping is your best defense against accidental commingling.

For investors, ignoring community property rules is like navigating the ocean without a compass. It directly impacts how your assets are controlled, divided, and taxed.

In the unfortunate event of a divorce, the community property framework mandates a clean 50/50 split of all community assets. This isn't a vague “fair” division; it’s a strict halving. For an investor, this can be devastating.

• Forced Liquidation: You might be forced to sell prized assets, like a concentrated stock position you intended to hold for the long term, to give your ex-spouse their half. This can trigger a hefty capital gains tax bill and disrupt your entire investment strategy.
• Valuation Headaches: Valuing complex or illiquid assets like a stake in a private business can become a contentious and expensive part of the divorce proceedings.

Community property rules also dictate what happens when a spouse dies. Typically, the surviving spouse automatically receives their 50% share, and the deceased spouse's share is distributed according to their will or state law. However, there's a powerful silver lining here for investors: the “double” step-up in basis.

• How it Works: In most states, when you inherit an asset, its cost basis is “stepped up” to its fair market value on the date of death, wiping out any prior capital gains. In community property states, when one spouse dies, both halves of the community property get this step-up.
• Example: A couple buys a stock portfolio for $200,000. When one spouse dies, the portfolio is worth $1 million. The surviving spouse’s new cost basis for the entire portfolio becomes $1 million. They could sell it the next day for $1 million and owe zero capital gains tax. This is a massive estate planning advantage.

Most U.S. states and countries like the U.K. operate under a “common law” system (also known as “equitable distribution”). The difference is critical.

• Ownership: In common law states, ownership follows the title. If your name is on the brokerage account, it's your property.
• Division in Divorce: Upon divorce, assets are divided “equitably,” which means fairly, but not necessarily 50/50. A judge considers factors like the length of the marriage and each spouse's financial contribution.
• Basis Step-Up: Upon death, only the deceased's portion of the property gets a step-up in basis, not the entire asset.

• Know Your Jurisdiction: The first step is to know whether you live in a community property or common law jurisdiction. This is the foundation of your financial and estate planning.
• Consider a Marital Agreement: A prenuptial agreement (before marriage) or postnuptial agreement (after marriage) can be used to define which assets will remain separate and which will be community property, overriding the default state laws.
• Keep Impeccable Records: If you want to keep your separate property separate, you must be able to trace it. Avoid commingling funds and maintain clear documentation showing the source of your separate assets.
• Consult Professionals: These laws are complex. Always work with qualified legal and financial advisors to structure your investments, plan your estate, and protect your assets in a way that aligns with your local laws and personal goals.