The Texas system of property rights for husband and wife is based upon a community property system. All marital property on hand at date of death or date of divorce is considered to be either the parties' separate or community property. The characterization of marital property is a fundamental issue for each practitioner assessing the parties' rights when the marriage ends by divorce or death or when a spouse sells or exchanges property. This article reviews rules, presumptions and tracing concepts that are tools in determining characterization. In addition to the complexities of characterization of marital property, the attorney or legal assistant must also consider any equitable claims created by the concept of reimbursement. This article discusses how reimbursement claims can arise and the measure of such claims.
A spouse's separate property includes the following:
· the property owned or claimed by the spouse before marriage;
· the property acquired during marriage by gift, devise, or descent; and
· the recovery for personal injuries sustained by the spouse during marriage, except any recovery for loss or earning capacity during marriage.1
Additionally, case law defines property directly traceable from separate property to also be separate property.2 By agreement, the spouses may create separate property. The Texas Constitution and Texas Family Code provide that spouses may partition and/or exchange their community property during marriage to create separate property.3 Spouses or persons intending to marry may agree that the income or property arising from separate property then owned by one of them or which may thereafter may be acquired shall be the separate property of the owner.4 For the property governed by such an agreement, the agreement effectively changes the general rule that during a marriage the income from separate property is community property. A complete discussion of premarital and marital agreements is beyond the scope of this article. Such agreements can change the characterization of marital property that would otherwise apply under many of the general marital property classification concepts discussed in this article.
Community property is not defined in the Texas Constitution. Texas law defines community property consisting of property, other than separate property acquired by either spouse during the marriage.5 Community property is defined by exclusion. In essence, all marital property which is not defined by the Constitution or by statute as separate property is deemed to be community property regardless of how such property has been acquired.6
The character of property is generally determined at the time of it's acquisition.7 This principle is called the "inception of title" rule. Inception of title occurs when a party first has a right of claim to the property by virtue of which the title is finally vested.8 For example, in Wierzchula v. Wierzchula, the husband entered into an earnest money contract to purchase a home before marriage. Thereafter the parties were married and the husband received a deed conveying the property to him after marriage. The Court found the real estate to be the separate property of the husband because the right of claim to the property existed prior to the marriage. If property is purchased with part separate and part community funds, the community estate and the separate estate own the property as tenants in common.9
Certain legal presumptions apply regarding the establishment of the character of marital property. All property acquired during the marriage and all property possessed by either spouse during or on dissolution of marriage, including death, is presumed to be community property.10 Separate property which has been commingled with community property is presumed to be community property.11 Because of the community property presumption, the party seeking to show separate property has the burden of proof which is by clear and convincing evidence.12
One method used to rebut the presumption of community property is tracing. A party must be able to show that a current asset held during the marriage can be traced back to an asset that was the separate property of a party. In essence, the form of separate property can change during the marriage and it will retain its separate property character as long as the exchange can be traced to the original separate property asset.13
One of the methods for determining or tracing a series of transactions is the clearinghouse method. In this instance, the proceeds of the sale of separate property is deposited into an account with the identical sum being withdrawn to purchase other property. The purchased property is then characterized as separate property because the source of the purchase money is separate property.
If a bank account contains both community and separate funds, it is presumed that community funds are drawn out first.14 Using the presumption that the community property is drawn out first, a party may trace funds on account by proving the account balance never fell below the amount proven to be separate property. This creates a presumption that only separate property remains after all other withdrawals have been made.
Although property in possession of either spouse during marriage is presumed to be community property, there is a presumption of separate property for real estate transactions in the following circumstances:
· if one spouse is the grantor and the other spouse is the grantee, it is presumed that the grantee receives property as the grantee's property;
· if one spouse furnishes separate property consideration and title is taken in the name of the other spouse, the spouse receiving title is presumed to hold such property as his or her separate property;
· if the instrument conveying title to the property contains a "separate property recital" which states that the consideration is paid from separate funds of a spouse or if the title instrument states that the property is conveyed to a spouse as his or her separate property.
Special classification rules apply to certain types of property. For example, a mineral royalty payment is considered the payment for the extraction of the natural resources of the land. Therefore, royalties paid for natural resources produced from separate property are separate property.15 If a bonus is paid pursuant to an oil and gas lease, the bonus is deemed to be a payment for sale of the minerals and thus the bonus takes on the character of the underlying lease. That is, if the lease is of a separate property mineral interest, then the bonus will be separate property.
The personal earnings of a spouse earned during the marriage are community property. However, monies received by a spouse after marriage for services rendered prior to the marriage are separate property.16 This rule may be changed by a premarital or marital agreement between the parties.17
Cash dividends from separate property stock are considered income and therefore are community property if received during the marriage relationship. Capital gains from appreciated stock represent the increase in value of the asset and therefore capital gains realized on the disposition of separate property stock are generally separate property.18
The characterization of corporate stock is determined by the inception of title rule. Therefore, stock owned before the marriage or acquired during the marriage by gift, devise or inheritance is separate property.19 However, this rule has been modified by Vallone v. Vallone.20 If a spouse expends time, talent and labor in the management or preservation of a separate corporate business beyond the amount of compensation received by the community estate for the time, talent and labor, the non-owner spouse may have a claim for reimbursement. If a spouse owns separate property stock in a corporation prior to marriage and upon termination of the marriage the stock has significantly appreciated in value, the appreciation would be separate property. However, if the individual efforts of the stock owner have contributed substantially to the increase in value of the stock without the owner being sufficiently compensated for his or her time and effort in growing the business, upon dissolution of the marriage the non-owner spouse may look to reimbursement as a way to be compensated.
A partner's interest in a partnership is generally characterized according to the inception of title rule.21 The community has no interest in the underlying assets of the partnership, but only the partner's rights in the partnership. Even if a partner's interest is separate property, the distributions of the partner's shares of profits and income received during the marriage are community property.22
The inception of title rule also applies to the characterization of life insurance policies. The characterization of the first premium payment as separate property or community property determines the characterization of the policy. Therefore, if a policy is purchased prior to marriage and the first premium is paid with separate property funds, then the policy is characterized as the separate property of that owner. Equitable claims arise when the owner marries and pays premiums for the separate property policy with community funds. Upon dissolution of the marriage, the community estate may seek reimbursement from the separate estate of the owner for the amount of premiums that were paid on the policy from community funds during the marriage relationship.23 Reimbursement issues are more fully discussed below.
One of the most difficult issues in community property characterization is the effect of community property law upon private retirement benefits. In a divorce situation, the inception of title rule does not apply. Texas follows a proportionate test. The portion of retirement benefits that accrues during the marriage is deemed to be community property.24
In testamentary planning the question of how to handle the non-participant spouse's community interest in retirement benefits has been a subject of much debate and dispute. In Allard v. French,25 the Texas Supreme Court held that the will of a non- participant spouse could dispose of her community property interest in the retirement benefit of the participant spouse at the non-participant spouse's death. Therefore, a non-participant spouse, by will, could give his or her community property interest in the participant spouse's retirement benefit to someone other than the participant spouse. Distribution of the benefits might be delayed until after the participant spouse retires.
The United State Supreme Court in Boggs v. Boggs26 essentially changed the Texas Supreme Court decision in the Allard case with reference to plans governed by the Employee Retirement Income Security Act (ERISA) . The Boggs case extinguished the community property interest of the non-participant spouse if that spouse predeceases the participant spouse. The United States Supreme Court has said that ERISA preempts and thus nullifies state community property laws as to undistributed benefits of any ERISA plan. Boggs does not apply to divorce circumstances (i.e., a spouse's community property interest in the participant spouse's employment benefits is divisible on divorce). It does appear that after Boggs, a will made by the non-participant spouse cannot dispose of his or her community interest in the ERISA plan assets arising from the participant spouse's employment upon the death of the non-participant spouse.
The Boggs case does not appear to apply to Individual Retirement Accounts because they are not covered by ERISA. The well-settled inception of title rule has governed the characterization of an IRA as separate or community property. However, uncertainty remains concerning the effect of the Boggs opinion on assets of an ERISA plan which are rolled over to an IRA before the death of the non-participant spouse. In that instance, the benefits can be traced to an ERISA qualified plan. If the Boggs decision negates any community interest of the non-participant spouse in the ERISA qualified plan, can a community interest arise upon conversion to an IRA? Practitioners hope that future case law or legislation will help resolve this issue and others created by the conflict between the Boggs case and prior community property law.
Marital property classification rules sometimes create inequitable results, but the concept of reimbursement addresses many such inequities. Reimbursement is an equitable right of accounting between the community and separate estates. Cases generally recognize the right of reimbursement between estates. However, the right of an estate claiming reimbursement is not a fixed right or title in the property, but is an equity claim. The basic rule is that if the assets of one estate (separate or community) are used to enhance another estate (other than by gift), a prima facie case for reimbursement is established.27 In most circumstances, a claim for reimbursement for funds expended by one estate for improvements to an asset owned by another estate is measured by the enhanced value.28 For example, if separate funds are used to make improvements to community property real estate, the equitable claim for reimbursement is the enhancement in value to the property, not the dollars actually expended for the improvements.
Enhancement is not the measure used for reimbursement where separate funds are used to reduce the indebtedness on a community asset such as real estate. In this instance the separate estate is entitled to reimbursement for the actual reduction in principal of the indebtedness during the marriage relationship. If the community makes premium payments on separately owned life insurance policies, a right of reimbursement may arise. However, if the beneficiary named on the life insurance policy is the other spouse, the benefit may be equal to the premiums paid and, thus, not give rise to a right of reimbursement. The general rule is that a claim for reimbursement of funds expended by an estate to pay life insurance premiums on a policy owned by another estate is measured by the amount of premiums paid less the value of any related benefit received by the spouse seeking reimbursement.29 Dakan v. Dakan makes it clear that reimbursement applies upon dissolution of a marriage at the death of one of the spouses.
In the Dakan case, the spouse improved his separate property with funds belonging to the community estate. The spouse then died. The Court indicated that the widow would have a claim of reimbursement that existed at death for community funds used to improve separate property. If, as it appears, a claim for reimbursement passes to the heirs or devisees of a Decedent, several potential problems may arise.
If the estate is insolvent, the personal representative of the estate may be under a duty to pursue this claim for reimbursement. Also, a conflict of interest could result if the surviving spouse is not the sole beneficiary. If the surviving spouse makes claims against other beneficiaries, this may deplete a gift to the other beneficiaries who may resent the surviving spouse's attempt to diminish their gifts. Some authors have suggested that a community property claim for reimbursement may be an asset that a creditor can attach in order to indirectly reach the separate property of the surviving spouse. In normal circumstances, the surviving spouse's separate property is not subject to the creditors of the deceased spouse. However, this might be a method that a creditor can use to reach otherwise protected assets.
Evaluation of reimbursement issues and classification of marital property as separate or community are crucial first steps in the analysis of the rights of spouses, creditors and others to any marital property. Any such analysis must consider both characterization rules and the effect of any premarital or marital agreements between the spouses. Understanding Texas marital property law enables a legal assistant to correctly identify key issues and necessary information for the characterization of marital property essential to many types of cases and transactions.
1 Tex. Fam. Code Ann. §3.001 (Vernon 1997)
2 Love v. Robertson, 7 Tex 6 (1885)
3 Tex. Const. Art. XVI, §15; Tex. Fam. Code §4.102 (Vernon 1997)
4 Tex. Const. Art. XVI, §15; Tex. Fam. Code §4.103 (Vernon 1997)
5 Tex. Fam. Code Ann §3.002 (Vernon 1997)
6 Hilley v. Hilley, 342 S.W.2d 565, 570 (Tex. 1961)
7 Hilley v. Hilley, 342 S.W.2d 565, 570 (Tex. 1961)
8 Wierzchula v. Wierzchula, 623 S.W.2d 730 (Tex. Civ. App.-Houston [1st Dist.] 1981, no writ)
9 Gleich v. Bongio, 99 S.W.2d 881 (Tex. 1937)
10 Texas Family Code §3.003 (Vernon 1997)
11 Tarver v. Tarver, 394 S.W.2d 780 (Tex. 1965)
12 Texas Family Code §3.003 (Vernon 1997)
13 Estate of Hanau v. Hanau, 730 S.W.2d 663, 667 (Tex. 1987)
14 Sibley v. Sibley, 286 S.W.2d 6757, 659 (Tex. Civ. App.-Dallas 1955, writ dism'd)
15 Norris v. Vaughn, 260 S.W.2d 676 (Tex. 1953)
16 Dessommes v. Dessommes, 543 S.W.2d 165, 170 (Tex. Civ. App.-Texarkana, 1976 writ ref'd n.r.e.)
17 Texas Family Code §4.003 and §4.102 (Vernon 1997)
18 Bakken v. Bakken, 503 S.W.2d 315 (Tex. Civ. App.-Dallas, 1973, no writ)
19 Jensen v. Jensen, 665 S.W.2d 107 (Tex. 1974)
20 Vallone v. Vallone, 644 S.W.2d 755 (Tex. 1982)
21 Norris v. Vaughn, 260 S.W.2d 676 (Tex. 1953)
22 Marshall v. Marshall, 735 S.W.2d 587 (Tex. Civ. App.-Dallas, 1987, writ ref'd n.r.e.)
23 McCurdy v. McCurdy, 372 S.W.2d 381, 384 (Tex. Civ. App.-Waco, 1963 writ ref'd)
24 Taggart v. Taggart, 552 S.W.2d 422 (Tex. 1977)
25 Allard v. Frech, 754 S.W.2d 422 (Tex. 1977)
26 Boggs v. Boggs, 117 S. Ct 1754
27 Dakan v. Dakan, 83 S.W.2d 620 (Tex. 1935)
28 Anderson v. Gilliland, 684 S.W.2d 673, 675 (Tex. 1985)
29 McCurdy v. McCurdy, 372 S.W.2d 381, 384 (Tex. Civ. App.-Waco, 1963, writ ref'd)
Nancy L. Hamilton is a sole practitioner in Houston, Texas who is a Certified Specialist in Estate Planning and Probate Law by the Texas Board of Legal Specialization.