0224: How to Handle Inheritances and Gifts in Divorce

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It's been a little while since I have done an episode and it's been a very busy couple of months, so apologies about that. But I want to discuss a topic that's been coming up quite a bit in the coaching calls.

 

And that is how you handle inheritances and gifts during a divorce. It's a tricky question. And it's an important question because oftentimes your parents, or someone, will leave you a substantial sum and you want to protect that during the divorce process. Sometimes that inheritance money comes at a poorly time to time where you can't control it. Someone passes away, unfortunately, and you receive some money maybe right before a divorce or during the divorce process. And you're trying to figure out, well, what should you do?

 

I just spoke with someone the other day who had filed for divorce and then, unfortunately, a parent passed away, eight months into the divorce process And they were wondering, "Well, how do we handle this new inheritance that arose, and what to do about that?" And so in this episode, I want to give you some tips when it comes to handling gifts or inheritances and how to protect that property. And really, the main thing is how do you prevent it from becoming a community property, which is the property that is subject to, or that you're going to end up having to split as part of the divorce process.

 

So let's go through a few quick tips.

 

The first thing is if you receive an inheritance, or you receive a gift from someone, keep that stuff in your name only. Meaning, if you get some money, let's just say a hundred thousand dollars, because I'm going to use that as an easy example. If the parent passes away and gives you a hundred thousand dollars, don't deposit that into a joint bank account. Set up a separate bank account that's in your name only. And we're going to call it your inherited funds account. And so put the money in that bank account separately so that it doesn't get commingled with the other assets. And that could get complicated because not always is an inheritance a gift. Sometimes it may be a home or a car or any other type of property. Whatever it is, make sure to title it in your name only.

 

The second thing is don't let your spouse make any contributions to that gift or that inheritance. And the house is the easiest way to illustrate that. If you inherit a house and let's just say it's been run down for a little and it needs some repairs to get it up to speed. Well, one of the things that you should do is don't let your spouse contribute financially to those repairs because the value increase of that house, or even the whole house itself, depending upon where you are, could now come into question as part of the divorce process. And sometimes this may be a house that you maybe just made renovations or adjustments on a few years ago, and now the divorce process is happening. And now you're wondering, "Well, is any part of that house marital property, because my spouse helped renovate the master bathroom and bedroom in there?" And so if that's your situation, be very careful and think through what you're going to do with that inherited property. And if you can keep your spouse from making contributions to it, financial or labor even, then you should do so.

 

The third thing is to consider transferring that inheritance or gift to a trust. Now, oftentimes a parent who was savvy in estate planning, or at least inheritance is most commonly from parents, which is why I use that example, are very savvy in their estate planning. And so oftentimes as part of their estate is they will give you that property, be it cash or the home or whatever, jewelry or whatever it may be, and they might require it to be put in a trust as part of the process. But if that wasn't the case for you, I would consider setting up a trust.

 

Now there are lots of complications and nuances to having a trust set up for you. But what I would do is if you have an inheritance coming, or you recently got one, or you're thinking about it, I would go and look for an attorney called an estate planning attorney or a trust attorney. And they're kind of one and the same and they can illustrate options for you to set up a trust. Now, usually, there are some fees involved, of course, we're talking about legal work, but it can be worth a little bit of trust set up in the short term to protect you in the long-term.

 

And then the last thing I would strongly suggest is to keep really good records about where the inheritance came from, how much money was in there, where the funds went, et cetera, et cetera. One of the most common things that I deal with and see people make a mistake with is not keeping track of the money and keeping track of the details of an inheritance. And so what can happen is, let's just say you got an inheritance seven years ago and you knew it was approximately $123,000 but you don't remember the exact math that was there. Well, one of the things that you can do, error the exact amount that was in there because seven years have passed and you want to know. Well, if you don't know what that amount was and your spouse is going to contest it in terms of how much was actually in that inheritance, you could be setting yourself up for a world of potential hurt in that you may end up losing part of your inheritance in the divorce process since you didn't keep accurate records.

 

And so, one of the things that is most important to do is make sure that you keep track of the paperwork. Keep track of any emails. Keep track of any bank statements. Keep track of any lawyer's correspondence or documentation to ensure that the information that you have from the inheritance is kept and kept track of over time and kept cleanly. Because one of the things that can happen is, let's just say, hypothetically, you've received an inheritance of that $123,000, and the next year you purchased the house with your spouse and use those funds as a down payment. That's something that's very common. And then three or four or five years or 10 years, whatever the amount is, goes by and now you're facing divorce. And you're like, "Well, I contributed $123,000 to that down payment of the house from this inherited gift."

 

Well, the good news is that even though you may not have followed my initial steps or initial tips, my tips one, two, and three, that you still may be able to get credit for that money as part of the divorce process and consider it still separate property if you have accurate records. But you need to make sure that you have very accurate records of where every dollar came from and where that inheritance money went. On the other hand, if you didn't keep accurate records, you may lose those funds and it may become a costly issue. And it's something that you want to be very careful about. So it's one of those things where you need to make sure that you find every piece of documentation that you have related to that.

 

Now I've been talking mostly in the context of inheritances because that's the most common, but oftentimes I also see a parent give a gift to you and or your spouse. And what can happen is some money flows in, it's usually pretty informal, gifts around $14,000 or so are not taxed. But sometimes they're bigger gifts. And you forget, because of the size of the gift, to go through all of the steps and document everything. You may have just had a phone call with your mom or dad and your mom or dad just said, "Oh, I'm writing you a check for, here's a $10,000 check for some spending money." And if you're fortunate enough to have parents who are in that position and then you're like, "Oh great. This is a good check." And you use it for something important, but you want those funds back as part of the divorce process because you feel it's appropriate given the situation.

 

Well, one of the things you should make sure that you do is you need to have a list of documentation from your parents. Your parents, your mom or dad should say, "Hey, I wrote you this check for $10,000." You should have some emails from the time of the check. You should have other correspondence from that time. And you should indicate that all of that stuff happened and happened smoothly because that way you can prove where those funds came from. But just because it's casual or just because you may not be thinking about it at the time and divorce may not have even been on your radar at the time of the gift, which is okay, but you need to make sure that whenever money is coming in from a source, particularly a family member, that those transactions are documented and you gather that documentation.

 

So the four most important tips for protecting your inheritance or gifts in divorce. And I'll just go through them quickly. One is to keep inheritances or gifts in your name only. The second is don't let your spouse make any contributions to that account or that property to ensure that it stays separate. The third is to consider contacting an estate planner and transferring that inheritance or that gift to a trust. And fourth is to keep really good records as to where that inheritance or gift came from.