how to protect inheritance from divorce

How to protect an inheritance from divorce

You built a substantial legacy and intended to leave it to specific heirs, say your children or adult grandchildren. But one of those heirs was in a bad marriage. Shortly after you passed away and bequeathed those assets, he or she got divorced. Now the spouse who you did not intend to receive any of your inheritance wants his or her share of the marital assets, and considers the legacy you left as part of those assets. It’s possible that a large chunk of your legacy will go to somebody who will no longer be part of your family.

Can you or your heirs prevent this from happening? Yes, but the inheritance has to be handled properly.

How an inheritance becomes marital property

If a person receives an inheritance, the law states that his or her spouse has no right to it during or after their marriage as long as the inheritance remains separate from marital assets. Unfortunately, this is rarely the case.

Losing control of an inheritance is as easy as depositing the money or proceeds from a property sale into a joint account. This is called commingling, which means you’ve mixed your personal assets with your marital assets.

Think of your marital assets like a glass of milk and your inheritance as some chocolate syrup. As long as you keep the syrup out of the milk, you the heir will keep full control of it. As soon as you mix the syrup in the milk, it becomes chocolate milk and you can no longer separate the two. If you divorce, you have to split the chocolate milk based on how the courts decide those assets should be divided.

Another example of commingling is taking money from an inheritance and buying something that is placed in both spouses’ names; for example a home, car, or business venture. Even if you didn’t spend the entire inheritance on the purchased asset, just the act alone commingles the entire inheritance and whatever is left is considered marital property.

In community property states, all marital property is divided 50/50 in a divorce. That means if you commingle an inheritance with your marital assets, your divorced spouse will essentially receive half of what is left of the inheritance. In equitable distribution states, judges decide how assets are divided but will likely give a portion of the commingled inheritance to your spouse.

Things get more confusing when the inheritance is property or other illiquid asset, such as real estate. A common issue is called transmutation. This is similar to commingling except that it happens gradually over time. For example, say you inherited your parents’ house and kept it in your name only. You might think it’s protected if you and your spouse divorce. But if you used marital money to make repairs or pay taxes, the property has more than likely become a marital asset. Likewise, if you take out a home equity loan to pay for the repairs, then use your income to make the monthly payments, you’re transmuting your property from a separate inherited asset into marital community property.

You don’t even have to spend money on the inherited asset for it to become marital property. For example, if the inherited house from your parents needed repairs and your spouse did the work, even if you used inherited money for materials, the court will more often than not recognize the home as marital property.

How to maintain control of inherited assets

When disputes arise in divorce proceedings, it’s usually the person who inherited money or property to prove that he or she kept the inheritance separate from marital property. Otherwise, the court will likely consider it marital property.

To keep this from occurring, the person receiving the inheritance should keep any money in a separate account in his or her own name. Furthermore, he or she should never deposit household income or assets of any kind into that account. And never use your own income, joint savings or household money of any kind to repair, market for sale, or pay expenses on an inherited asset.

The most effective way to avoid this situation is for the parties giving away the inheritance to place them in a trust. Working with an attorney, they can designate the trust as owner of the property. Therefore, it would not become marital property, but the intended heir could still access it through the trust agreement. Trusts are also an effective way to put aside money to maintain a house or other property so that the heir does not have to use martial assets to pay those expenses.