Community Property Law and Community Property Agreements

It is important for married couples, and those contemplating getting married, to understand community property concepts.   

Marriages end by death or divorce. Married individuals often desire to leave everything at death to the surviving spouse. And folks want to do so as easily, as efficiently, as quickly and as cost effectively as possible.  Often the best way of doing so (for Washington residents) is by entering into a written Community Property Agreement with your spouse as part of your estate planning.  

Washington is one of about ten "community property" states. Most community property states are in the West. Oregon and Montana are two nearby states that are not community property states.  

Community property laws primarily determine how property is owned by married couples.  Assets are either characterized as  the “separate property" of the husband, the “separate property” of the wife or the "community property" of both spouses.  

Generally, separate property is property that you owned before you were married and property that you alone acquire during the marriage by gift or inheritance.  Community property on the other hand, again generally stated, is property that a married couple acquires while living in a community property state through the employment of one or both of the individuals during the marriage.  

Each of the spouses owns an “undivided one half interest” in all of the community property.  That is, if the couple owns 100 acres of land as community property, each does not own 50 acres. Rather, the husband and wife together own undivided 50% interests in the entire 100 acres.  

Incidentally, it should be noted that community property laws apply, of course, to the marriages of same sex couples. For the sake of simplicity, this article references the spouses as husband and wife.  

It should also be noted that the law gets more complicated when couples live together in long term committed relationships outside of marriage. Unmarried couples who are living in such arrangements should certainly have a good understanding of the law regarding “quasi-community” property and related concepts. An explanation of that is beyond the scope of this article.  

Contrary to what some people thing, separate property does not automatically become community property the moment the couple marries.  Rather, separate property retains its separate status throughout the marriage, unless something changes that.  Couples that sign a valid and enforceable Prenuptial Agreement prior to marriage or Postnuptial Agreement after marriage may designate whether property and income of the parties owned by either spouse when the marriage begins and acquired during the marriage is to be considered separate property or community property. That is, by such a written agreement, the married couple may, in essence, change the application of Washington’s community property law.  

In Washington, assuming no nuptial agreement of any sort and no Community Property Agreement has been entered into by the parties, each spouse has the power to dispose of all of his or her separate property by Will (or otherwise) as he or she wishes.  Each also has the power to dispose of his or her one half of the community property as he or she wishes.  There are some exceptions to this general rule. A spouse may, for instance, be entitled in some situations to a portion of the deceased spouse's estate as a "spousal allowance" if the deceased spouse does not make a sufficient bequest to the surviving spouse. Also a Federal law called ERISA puts some limits on a spouse if he or she wants to leave certain types of retirement benefits to someone other than a surviving spouse.  

A Community Property Agreement changes the ownership status of, and implicitly the right to manage, the property of the parties.  The Agreement is executed by both spouses and generally does two specific things.  

First, it converts separate property into community property.  Ordinarily it converts not only the separate property then owned by the parties, but also any separate property that may be later acquired (such as by gift or inheritance).  Various reasons may exist to not convert certain separately held property (such as an interest in a family farm or business) and in those instances such assets can be specifically excluded from being converted by the Agreement.  The point in time that the conversion of ownership actually takes place may be either at the time the Agreement is signed or at another point in time (for example, at the moment of the first spouse's death), depending on how the Agreement is written.  Various factors should be considered in deciding whether or not all property should be included and when that conversion should become effective.  

The second thing a Community Property Agreement does is, upon the first spouse's death, it automatically conveys the deceased spouse's entire interest in all of the community property to the surviving spouse.  Thus, when a Community Property Agreement exists, there is generally no need to utilize the Will and probate the estate of the first spouse to die, unless there exist probate assets that were specifically excluded from the Community Property Agreement.  

This second function of the Community Property Agreement, that automatic conveyance of all assets to the surviving spouse at the moment of the death of one spouse, is perhaps the most common and most reliable way for married couples to avoid probate in Washington State.  If such a Community Property Agreement has been executed, when the first spouse dies the Agreement and a certified copy of the death certificate are recorded in the county Auditor's office and no probate of the estate of that first spouse to die is ordinarily required.  

COMMUNITY PROPERTY AGREEMENTS ARE NOT FOR EVERYONE  

There are some drawbacks to Community Property Agreements.  If one spouse owns separate property which he or she does not want to pass to the other spouse, entering into such an Agreement should be avoided.  

For instance, in situations involving second or third marriages, spouses may not want to leave everything outright to each other.  It is not uncommon for a spouse in that situation to want to provide some assets or income to a surviving spouse after the individual's death while at the same time leaving certain assets or amounts of money to children from a prior marriage.  Similarly, in second or third marriages, individuals occasionally desire to leave some or all of the separate property, and even the deceased spouse’s interest in the community property, "in trust" to a surviving spouse so the surviving spouse can have the use of property such as a home or the use of income from investments during the survivor's lifetime.  Then, upon the death of the surviving spouse, the desire is often to have everything in the trust pass to children of the marriage and/or children from an earlier marriage, or to a favorite charity.  In situations where bequests to a non-spouse are to be made "in trust" to a spouse, Community Property Agreements should often (but not always) be avoided.  

Another instance where a Community Property Agreement is best avoided or where such an Agreement must be carefully drafted arises when one of the spouses is to obtain an interest in a family business or a family farm which the family intends to keep entirely in the family.  Parents or grandparents may direct that when the family farm or the family company is handed down to the children or the grandchildren, no interest should pass to the in-laws because in-laws are not blood relatives.  Community Property Agreements can upset such a family plan. (A properly prepared Buy-Sell Agreement entered into by the owners of the closely held family business can overcome some of those concerns.)  

Another situation where a Community Property Agreement may not be advisable arises when a married couple has a high value combined net worth such that estate taxes are a possibility upon the death of a spouse.  Spouses with significant wealth should obtain a good understanding of how state and Federal estate taxes, and Federal gift taxes, are applied, and how those taxes can be avoided or minimized.  

On occasion a review of an older estate plan which included a Community Property Agreement may reveal that the couple's situation has changed and that the Agreement is no longer desired.  Often this is the case when one spouse needs expensive long term care and Medicaid qualification planning becomes necessary.  In those instances the Community Property Agreement can be revoked if done properly and if done in writing.  However, because the Agreement is a contract between two individuals, both parties will typically need to execute the revocation. An agent acting with the proper legal authority under a well-written Durable Power of Attorney may be able to execute such a revocation document on behalf of an incapacitated spouse.  

In summary, Community Property Agreements are often very beneficial and can truly be an effective and cost saving estate planning tool for many married couples.   

Restraint should be exercised when considering using a preprinted Community Property Agreement purchased from the local stationary store or found on the Internet, much like restraint and good sense should be used when considering writing your own Will or Durable Power of Attorney on a home computer with a computer program "valid in every state".  

Keep in mind also that a Community Property Agreement does not do away with the need for Wills for the married couple.  Although the estate of the first to die is not ordinarily probated and thus that individual's Will is not often utilized, upon the second death the Community Property Agreement has no effect and therefore the estate of the second spouse may need to be administered pursuant to the instructions in the Will.  

In addition to a Community Property Agreement (when such an Agreement is appropriate), an estate plan should include, at a minimum, Wills executed by each of the spouses, Durable Power of Attorney instruments executed by each of the spouses and Advance Medical Directives executed by each of the spouses. Beneficiary forms on nonprobate assets and names of owners on financial accounts should also be reviewed and updated periodically.  

Good and complete estate planning involves many considerations that are not always as simple to understand and address as people would like.   

Please contact Dan if you would care to schedule an estate planning conference.