Separate Property Trust as an Alternative to Prenups

Even though love is grand, the incidence of marital separation is not trivial. Subsequent marriages carry an even higher rate of failure. One should not plan for divorce but rather be prepared for it, just as one should generally be prepared for misfortune by having in place estate planning instruments like wills, trusts, and other directives.

Community and Separate Property

When a divorce is initiated and the spouses go to divide their assets, the first thing they will have to do is identify which is community property and which is separate property. The community property will be split among the parties equally and the separate property will be retained by the spouse who has been its owner. As you can see, the more property that is in separate property status versus community property status, the less transferring will take place. In many states, income and property acquired with it during marriage are treated as community property and they will be split between the parties.

There are exceptions that occasionally apply, such as pre-marital property, gifts and inheritance or property covered by a valid, written agreement in place before the marriage. In some states, personal injury recoveries are treated as separate property. Assets that are purchased with separate property may maintain the character of separate property, particularly where the purchased asset is titled solely in the name of the owner party, not both parties. For example, consider a situation where a spouse inherits $250,000 and placed it in a separate account in her name. She then purchases a speedboat with $150,000 and registers it in her sole name. This evidence could be used to maintain the separate property nature of the boat.

California and Community Property

California is a community property state and each spouse will be awarded an equal interest in the community estate, absent a written agreement of the parties (California Family Code §2550). If during a marriage, one spouse uses his paycheck to buy a piece of real or personal property, that property is community property because the paycheck is community property, absent a previous written agreement.

Under trust law, the focus is on the intent of the settlor (the party that creates the trust, usually the donor). A beneficiary of a trust has an equitable interest in the trust property, but she does not hold legal title to trust property. For this reason, courts generally recognize that property as separate property. However, because marital law does not focus on the intent of the settlor, and is bound to state law, including the state’s constitution, it may promote a different outcome. This is particularly true with interest income to the trust.

Trust Income

Depending on the nature of the trust (and there are many kinds), income from the separate property in the trust may remain separate property if it is placed in a separate property account and not commingled with marital assets. To be consistent, the law determines community property that is moved to a trust to remain community property. One cannot shield assets that are marital from being distributed equally between the parties. On the other hand, if a party deliberately acts to an extent that the separate property appreciates, whether by running the household while the other party nurtures the separate property business, or by directly aiding the organization, the increase in value could be treated as community property.

Compatible with Prenups

If the parties contemplate the pros and cons and decide ultimately to execute a prenup, this will not conflict with a trust. In fact, it would add consistency and a layer of redundancy to help ensure that planning goals were met. It might be beneficial to include a clause for each party in the prenup identifying the property of each party as their own separate property with a corresponding intent for it to remain separate property. Similarly, the parties may want to include a clause designating separate earnings of each party as separate property of that party and declaring that commingling separate property or earnings shall not convert its character to community assets.

Out-of-State Couple

If a married couple moves to California, and then divorces, a layer of complexity is added to the situation. Depending on whether they intend to be permanent residents or whether, for example, they are just buying a vacation home, the law will treat them differently. If they are just visiting from a common law or non-community property state, the characterization of their property will not likely change without more action, such as a written agreement to convert separate property into community property.

Fraudulent Conveyance Law

The use of a trust may be able to protect your assets in the case of marital dissolution. Care must be taken to make sure that a conveyance is not seen as an attempt to shield assets from recovery. This might be the case if you are using an offshore irrevocable trust, for example. A creditor might attack your asset protection plan even though it was set up in the context of marriage. The federal Bankruptcy Code and some state laws contain fraudulent conveyance provisions, including states that have adopted a version of the Uniform Fraudulent Conveyances Act (“UFTA”). These provisions must be considered when one engages in any asset protection planning that involves transferring property to a third person, including the trustee of an irrevocable trust. The more aggressively one commits assets to asset protection strategies, the more probable it is that a creditor may be able to successfully argue a fraudulent conveyance, particularly where the strategies do not have a significant purpose other than asset protection.

When you are in the throes of romance, the highly variable aspects of estate planning do not generally become miraculously clear. They escape a black and white analysis and for that reason and for peace of mind, you should contact our knowledgeable trust specialists and run your situation by them. If you have concerns for a loved one or friend, please do not hesitate to contact one of our lawyers for legal advice. Call the trusted estate planning attorneys at Lowthorp, Richards, McMillan, Miller & Templeman at (805) 981-8555 or fill out our online contact form. We operate primarily in the Tri-Counties area – Ventura, Santa Barbara, and San Luis Obispo.

NOTE: The information contained herein is not intended to be legal advice and the reader should know that no Attorney-Client relationship or privilege is formed by the posting or reading of this article which is also not intended to solicit business.

Cristian R. Arrieta, Lowthorp Richards McMillan Miller & Templeman, A Professional Corporation, 300 E. Esplanade Drive Suite 850, Oxnard, CA 93036