By Kerrin Liu and Anthony Diosdi
In California, when a spouse becomes liable to a third party, either as a result of a tort claim or debt, the other spouse may be held liable for those debts. This is because most of the assets of married spouses in California are community property. This means that a spouse’s earnings are community property, and assets acquired during the marriage are community property. In contrast, the rules governing a spouse’s separate property are different. The separate property of a non-debtor spouse is not liable for the debts of the debtor spouse, whether the debt arose prior to or during the marriage.
California law regarding holding real property is significantly different than most other states. This is because most states allow a form of property ownership known as “tenancy by the entirety.” If real property is held in a “tenancy by the entirety” form, and only one spouse who owns the property is a debtor, that spouse’s creditors cannot seize or even encumber the property so long as the spouses remain married. A tenancy by the entirety cannot be severed without the consent of both spouses.
Even though California law does not recognize a “tenancy by the entirety” form of ownership of real property, Section 850 of the California Family Code may permit ownership of property that is similar to “tenancy by the entirety.” Section 850 provides that property may be transmuted through a “transmutation agreement.” Through a “transmutation agreement,” spouses in California may effectively remove themselves from the California community property system. To be valid, a “transmutation agreement” must be made in a written express declaration that is consented to or accepted by the spouse whose interest is adversely affected. The writing must expressly declare that a change in the ownership of property is being made. A well drafted transmutation agreement may protect the assets of one spouse from being reached by the creditor of the other spouse.
There are three requirements necessary for a transmutation agreement to mimic a “tenancy by the entirety.” First, there must be a valid transmutation agreement in place. In order for the transmutation agreement to be effective against creditors, the agreement must be recorded. Second, the spouses should hold the property as “sole and separate property” or the deed transferring title to each spouse should be in the form of “tenants in common.” Finally, the transmutation must not be a fraudulent conveyance.
This is an incredibly complex area of law. Anyone considering utilizing a transmutation agreement to protect assets from creditors, should seek the assistance of qualified counsel.
The tax attorneys at Diosdi Ching & Liu, LLP represent clients in a wide variety of domestic and international tax planning and tax controversy cases.
Anthony Diosdi and Kerrin N.T. Liu is are partners and attorneys at Diosdi Ching & Liu, LLP, located in San Francisco, California. Diosdi Ching & Liu, LLP also has offices in Pleasanton, California and Fort Lauderdale, Florida. Anthony Diosdi and Kerrin N.T. Liu represent clients in federal tax controversy matters and federal white-collar criminal defense throughout the United States. Anthony Diosdi and Kerrin N.T. Liu may be reached at (415) 318-3990 or by email: firstname.lastname@example.org; email@example.com.
This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.