How is a Community Property Agreement used in Estate Planning?
By BRANDON DOCKINS, Legal Intern
What is Community Property?
Community property is property owned by a marital community or a domestic partnership whereby each spouse or partner has a present, undivided, one-half interest in the property. RCW 26.16.030; Olver v. Fowler, 161 Wn.2d 655, 670, 168 P.3d 348, 356 (2007). This means each spouse or partner has equal access to the whole property, but only owns one-half of the property. Thus, each spouse or partner can control the property as an owner of separate property would, subject to limitations. RCW 26.16.030. Particularly, without the consent of the other spouse or domestic partner, a spouse or partner may not (1) devise or bequeath by will more than one-half of the property, (2) give away, sell, convey, or encumber community property, or (3) purchase real property with community funds. Id.
Property earned during the marriage or partnership is presumed to be community property. Id. This does not include property acquired by gift, bequest, devise, descent, or inheritance before or during marriage, or any rents, issues, and profits derived from separate property. RCW 26.16.010; RCW 26.16.020.
What is a Community Property Agreement?
A Community Property Agreement is a contract between spouses or domestic partners that allows the couple to classify property as separate or community property. RCW 26.16.120. Such an agreement can apply to property currently held and property that will be acquired in the future. Id. Further, the agreement can provide for property to be classified one way during life and another way upon the death of one spouse. Id. A Community Property Agreement is executed with a written instrument and must be recorded in the same manner as a deed to real estate. Id.
How is a Community Property Agreement used in estate planning?
The flexibility of a Community Property Agreement can help achieve various ends in planning for an estate.
- Insulate assets from creditors of one spouse or partner. By classifying assets as the separate property of one spouse, you can insulate those assets from the creditors of the other spouse. RCW 26.16.190. However, if the agreement is made to defraud creditors, a judge can set aside or cancel the contract. RCW 26.16.120. As such, it is critical to consult an attorney when considering such a move.
- Avoid probate. Because a Community Property Agreement can change the status of property upon death, a couple can provide that all property, whether separate or community, is to be classified as the separate property of the surviving spouse – thereby avoiding probate (and ancillary probate).
- Shape ownership rights. Owners of community property have different rights than owners of separate property, such as the ability to sell or encumber the property. As such, couples can convert community property into separate property if they want one spouse to have unilateral control; or, in the alternative, the couple can convert separate property into community so that both must take part in the decisions.
- Clarify ownership. When community and separate assets are commingled there is potential for separate property converting to community property. In re Binge’s Estate, 5 Wn.2d 446, 466, 105 P.2d 689, 697 (1940). This can happen when community funds are used to pay for the cost of the separate property, such as the monthly payments or property taxes. When there is room for doubt as to the status a costly battle in court can arise. A Community Property Agreement can preempt all disputes as to status and thereby avoid costly litigation between what are usually family members.
Although this route may be ideal for some estates, Community Property Agreements have some inherent limitations and can also have unforeseen consequences in certain circumstances that limit its applicability.
Because Community Property Agreements can only govern the status of property owned by a community in a community property state, this agreement (i) does not avoid probate for the surviving spouse or for property not in a community property state, (ii) does not provide for gifts to children and (iii) may be disregarded if moving to a non-community property state.
Also, because the agreement is a legally binding contract, the agreement (iv) survives a divorce and, if converting separate to community property, (v) limits your ability to control and manage the property if the other spouse or partner becomes incompetent or refuses to cooperate.
Further, a Community Property Agreement (vi) may be set aside or canceled by the superior court for fraud or other equitable grounds, such as an attempt to evade creditors. RCW 26.16.120. Finally, because the asset does not pass through probate, (vii) you lose the advantages associated with probate, such as tax benefits and creditor non-claim statutes. See, e.g., RCW 11.40.051.
Other potential drawbacks depend on the surrounding circumstances:
- Family LLC complications. Consider an interest in a Family LLC held by the husband as separate property. In some instances, Family LLC bylaws may require that only blood relatives own a share in the company. However, converting the husband’s separate interest into community property will give his wife, a non-blood relative, a share of the company. This can result in a loss of ownership or trigger some unfavorable action by the LLC, depending on the bylaws.
- Unintended disinheritance. Community Property Agreements override the end of life provisions in a will or trust that predates the agreement, which can result in an unintentional disinheritance. For example, if a husband’s will provides that an asset will be gifted to his brother but later provides that said asset will transfer to wife as separate property under a Community Property Agreement, the agreement will preempt the gift – resulting in the asset transferring to the wife rather than the brother. Estate of Lyman, 7 Wn. App. 945, 503 P.2d 1127 (1972), aff’d, 82 Wn.2d 693, 512 P.2d 1093 (1973).
- Repercussions upon divorce. In Washington, when dividing assets upon divorce, judges will take the status of property into consideration. RCW 26.09.080. Although the consideration is not absolute, courts may give deference to the classification and often give each spouse half of the community property. See, e.g., In re Marriage of Zier, 136 Wn. App. 40, 46, 147 P.3d 624, 628 (2006).
- Loss of Medicaid benefits. To qualify for Medicaid you must meet certain financial requirements. Although a Community Property Agreement can be used to meet this requirement, it also has the potential to prevent a spouse from qualifying if the agreement converts all attained property to community property and the other spouse buys property with separate funds. As such, while the agreement is in effect, the couple would have to decide between eligibility for Medicaid and acquisition of property.
A Community Property Agreement can be a valuable estate planning tool. However, due to the potential and actual drawbacks, this option is not ideal for all estates. Determining the potential consequences of a Community Property Agreement can be an onerous task and is best suited for an experienced attorney. The attorney’s at Wolff, Hislop & Crockett are skilled in estate planning and can advise you regarding options to address your individual circumstances. Contact us today for a consultation.