Is Inheritance Community Property or Separate Property in California?

This answer is more complicated.

Assume the inheritance is cash or became cash (inherited property was sold and cash deposited into an account). And then the spouse who inherited the money bought other property during the marriage with that inheritance. What happens then?

First, if a spouse receives an inheritance, does not commingle that money with community property money, and buys property with the inherited money, that spouse has a good argument the property is separate property.

That spouse however may have another problem. If the spouse acquired the property with the inheritance but did not first give his or her spouse the opportunity to discuss the issue and determine whether community property funds should have purchased the property, the other spouse has an argument there was a potential breach of fiduciary duty.

Spouses are fiduciary to each other. They cannot take financial advantage of each other.

If that property was a good investment and there was community property funds available to purchase it, but the spouse with the inherited money never considered that or unreasonably dismissed it, the question becomes whether that was unfairly taking financial advantage of the other spouse by not giving him or her the benefit of investing in that property.

The hypothetical of purchasing property with inherited money becomes more complex, if the spouse who inherited the inherited money commingled money with community property money.

What matters here is the amount of commingling. For example, if the inherited money was deposited into a joint account but only for a short time before it was used to purchase property, there probably is not enough commingling to create a problem. This assumes there is a clear tracing of the inherited funds from entrance into the joint account through exit from the joint account.

But if the inherited funds went into a joint account or any other account where there was community property funds, and money came in and out of that account to the extent where it is more difficult to trace the remaining money months or years later as community or separate, the issue is no longer clear.

In such a situation, one or both spouses may need to hire the appropriate experts such as a forensic accountant to conduct a tracing of community versus separate property funds in and out of the account.

Here is the scenario - Spouse number 1 received through an inheritance a house. The house is not paid off at the time, so it has a mortgage. However, the house also has equity. During the marriage, community property money (earnings or savings for example) pays down the mortgage principal, interest or both, and pays property taxes. Perhaps the community property money even improves the house.

That situation may create a community property interest in the house, give the community property estate a reimbursement right, or a combination. Read our article on Moore Marsden claims, as they are called, to learn more.

If property is partially from inheritance money and partially from community property money, that property is both community and separate property.

The most common scenario is the purchase of a house during the marriage where one spouse may use their inherited funds as a partial or full down payment but after that, community property funds pay the mortgage, taxes, insurance, improvements to the property and just about everything else. In such a situation, the spouse who paid the down payment with inherited funds may have a Family Code 2640 reimbursement claim.

Using inherited funds to acquire any asset or investment during the marriage may create the same community versus separate property disputes. The hypothetical we gave you above and the result does not just apply to acquiring real estate.

If inherited funds are commingled with community property funds and those funds are used to purchase any type of asset or even invest it in stocks, bonds, annuities, life insurance or any other investment, the same potential commingling and tracing issues apply.

This becomes especially complicated when both community property money and inherited money invest in an asset such as equities that increases or decreases in value due to market conditions.

The first and most obvious thing a spouse can do to keep their inheritance their separate property is to never commingle it with community property and never place their spouse on title or otherwise give their spouse any ownership interest.

Doing any of those things creates legal arguments against the separate property nature of the inheritance.

In addition, clear communication with their spouse regarding the intent with that inheritance money or property, and hiring an experienced attorney to document the agreement regarding the use of that money will avoid surprises if there is a divorce. An estate planning attorney can also give advice regarding how to keep the funds separate.

If the spouse who inherited the money wants to acquire assets, clear communication with their spouse regarding whether community property money should instead be used, why or why not and reaching a fair and reasonable agreement on this topic is important to avoid breach of fiduciary duty claims.

Consulting with an experienced attorney with knowledge of such issues will also help avoid mistakes or breaches of fiduciary duty.

Assuming you hired an experienced and skilled family law attorney like those at our firm, the steps are straightforward.

First, we gather all the information and documents available regarding the inheritance received and exactly what happened with the money or property after receipt.

Second, we determine if there is already a clear tracing of the money or whether a forensic accountant needs to get involved to conduct a tracing. If the inheritance was property, we look at whether community property money was paid toward it or whether title or ownership changed at any point.

Third, we complete any tracing with the help of a forensic accountant and advise our client whether the inheritance money and increase in its value remain separate property, and/or whether the inherited property is separate property, community property or both.

Unless there is a real factual dispute regarding this issue, the spouses should be able to settle such issues without extensive litigation.

In cases that involve significant commingling or potential breaches a fiduciary duty, litigation is likely depending on how much money is involved. For example, an inheritance of $50,000 will probably not justify much if any litigation whereas an inheritance of $10 million commingled over many years of marriage with community property money may cause significant litigation.