What’s Mine is Mine—What’s Yours Is Ours

BY HANNAH HEMBREE BELL AND ROBERT METZ

Everyone remembers learning the basic parameters of separate and community property for the bar exam: If you owned the property prior to marriage or inherited or were gifted it during the marriage, it's separate property; otherwise, it's presumed to be community property.

Simple enough, right? In theory, yes. In practice, drawing and maintaining the line between separate and community assets can get fairly complicated. Below are three crucial ways you can hold the line both before and after you say, “I do.”

GOLD STANDARD: PRE-MARTIAL AGREEMENT

Spelling out how your and your future spouse’s assets will be treated in the event of divorce may not be the most romantic option out there, but it’s certainly the cleanest.

Pre-martial agreements (aka “prenups”) allow you and your sweetheart to alter the property characterization framework as it applies to your specific situation. Perhaps you two don’t want to create any community property during your marriage—that’s an option. Or, maybe you want to carve out the way a specific income source is treated—you can do that, too.

But, if you decide to go this route, consider hiring an experienced characterization and tracing expert to review your agreement before you sign. The intent—and thus effect—of a prenup can be lost if the wording is not clear. Then, be sure to refer back to your prenup periodically and make sure you are living by the provisions. Otherwise, you may face challenges or arguments about the prenup in the event of a divorce.

PAPER THE FILE

The key to proving separate property claims (by the required clear and convincing evidence standard, or “CCE”) is maintaining detailed records. At a minimum, you need to be able to show the value of your separate property assets the day before you get married or at the time you receive the gift or inheritance during the marriage. But, to go the distance no matter how complicated your financial situation becomes, you’ve got to paper the file:

1. Keep all bank and brokerage account statements for accounts where you’ve placed separate property funds. In the digital age, you may think, “Oh, if I ever need those I’ll just grab them from the bank.” Wrong. Financial institutions won’t keep your records forever; most purge their files after seven years. So, set a time once a year to save your monthly statements to the cloud. Your future divorce lawyer and tracing expert will thank you.

2. Hold on to closing statements for real property transactions. Don’t throw those cumbersome, legal-sized, title company folders in the trash. They may come in handy if you need to prove the separate property you used for a down payment or trace a 1031 exchange someday.

3. Gifts: Say “thank you” but also “sign here.” We all remember the elements of establishing a gift—intent, delivery, acceptance—with all the interesting law school problems turning on establishing the intent element. The same is true in real life. Get divorced, and you will have to prove by CCE that the $10,000 check from your mom was meant as a gift to you and you alone.

To avoid situations where the gift is contested and your mom is dragged into a deposition to testify about the gift, best practice is to contemporaneously document the gift. For example, you could draft a declaration of gift for the giftor’s signature, have her add an annotation to the memo field of the check, and/or keep other forms of written communications between the giftor and recipient documenting the gift.

YOUR BUSINESS—FORM IT, FUND IT, RESPECT IT

Form it. Fund it. Your legal practice or side hustle woodworking business can be a significant part of your portfolio of assets. If formed before marriage, the entity is separate property. In Texas, even if your separate property business appreciates significantly during marriage, the entire company (and its growth) remains your separate property. To preserve that separate property interest, you need to ensure you’ve followed all the formalities to complete the formation of your firm.

So, after you’ve filed your formation documents, make sure you draft an operating agreement and properly fund the entity. For the operating agreement, sign it and clearly document the total initial contribution(s) (often a nominal amount like $1,000). Then, set up a separate bank account in the name of the business and deposit the initial contribution from your personal funds. Having all these items completed, dated, and recorded prior to marriage will go a long way toward solidifying your separate property claim.

Respect It. Now that you’ve gone through the headache of setting up your practice, make sure you respect the boundaries between your personal finances and your firm’s finances. In other words, whether separate or community property, don’t treat your business like your personal piggy bank.

It is easy to fall into the bad habit of making personal expenditures using business bank and credit card accounts. Similarly, a business owner may consistently use personal funds to make business expenditures without being reimbursed. The severity of the consequences of these bad habits can vary from simple adjustments to financial statements (and business valuation, if a community property business) to claims of fraud and/or alter-ego in an attempt to pierce or reverse pierce the corporate veil.

In sum: Get a prenup, hang on to your financial docs, and maintain your entity’s corporate form. Hopefully you won’t need any of it. But if you do, your future divorce lawyer and tracing expert will thank you. AL

Hannah Hembree Bell of Hembree Bell Law is a family law and estate planning attorney serving families in the greater Austin and San Antonio areas.

Robert Mertz is a forensic, litigation, and valuation partner with Whitley Penn in its Austin office. He is a certified public accountant (CPA), accredited in business valuations (ABV), and a certified fraud examiner (CFE).