By Board Certified Las Vegas Divorce Lawyer Vincent Mayo
Revocable family trusts may give rise to an issue that could be of paramount importance in a divorce case: Whether the revocable family trust transmutes separate property into community property.
An analysis of the issue starts with an examination of a revocable family trust. A revocable family trust is an inter vivos living trust, or in other words, a trust created during the lives of the grantors. A family trust creates a legal contract that outlines the management and distribution of the trust’s assets. Such a trust is effective once it is funded and permits the grantors to manage the trust estate during their lives. A revocable family trust can serve numerous purposes, the most common one being the avoidance of probate.
Having a will go through the probate process is often an expensive and time-consuming process. In contrast, a family trust allows for the immediate and inexpensive transfer of assets from one spouse to the other upon either spouse’s death. Revocable family trusts can also avoid will contests and provide privacy since a will that is probated becomes a public document. Further, since the trust is revocable, the parties are not “locked in” long term and they can terminate the trust, often unilaterally, if either spouse believes it is no longer beneficial to have the trust.1
Another common benefit to revocable family trusts is that they can result in beneficial tax treatment to a married couple. Upon the death of either spouse, their businesses, real estate and stocks may receive a full step-up in basis if they are “deemed” community property. This means that when property is classified as community property and one spouse dies, the cost basis of both the deceased spouse’s half and the surviving spouse’s half are increased to the asset’s fair market value at the time of the first spouse’s death.2 The full step-up (also called a “double step-up”) could potentially save a surviving spouse thousands of dollars in capital gains tax. In contrast, any property considered separate in nature receives a partial step-up in value representing only the deceased spouse’s interest. Couples may therefore be counseled by their tax advisors to include separate property in a trust and designate it as community property in an effort to take advantage of the full step-up.
The issue that arises in a divorce is whether the classification of separate property as community property in a revocable family trust transmutes one spouse’s separate property into community property.3 The matter is not settled in Nevada and is therefore open to two competing positions, one against transmutation through a revocable family trust and the other for.
The Arguments Against Transmutation
Lack of Intent: An argument against transmutation is that spouses typically only treat separate property as community property in their trusts in order to take advantage of tax laws or to allow for an easy transference of their estate. It is not because they truly mean to make one spouse’s separate assets community in nature.4
This is supported by the fact that most family trusts state that upon revocation, the assets in the trust retain their original separate or community character. In Sprenger v. Sprenger, the Nevada Supreme Court held that the transmutation of separate and community property must be shown by clear and convincing evidence.5
The obvious tax and estate planning motives behind characterizing separate property as community would seem to prevent the meeting of that burden. This is persuasive since under Cord v. Cord, 6 the intent of the parties as uncovered through evidence is a factor in determining whether property has been transmuted.7
Lack of an Express Declaration
A lack of express language in a family trust that transmutes property, it is argued, would also bar a transmutation. In the case of In re Marriage of Starkman, the Court of Appeals of California held that husband’s separate property placed into a family trust established by the parties did not become community property simply because it was labeled as “community property” in the trust.8
Rather, the court reasoned that due to the considerable consequences of transmuting the nature of property, there must be an express declaration that “A change in the characterization or ownership of property is being made.”9 As stated in the case of In re Marriage of Koester, one simply does not “… slip into a transmutation by accident.”10 A similar analysis was conducted by the California Court of Appeals for the Second Appellate District in Barker v. Barker when it found that the mere listing of separate property in a joint tax return as community property did not amount to an express declaration of transmutation.11 Also, if not all of the trust documents (i.e. the trust agreement, the trust asset schedules, deed of trusts, a certification of trust, amendments to the trust, etc.) evidence that a transmutation has taken place, or better yet take a contradictory position, it would be hard to show the intent was clear and convincing.
This need for an express, clear declaration is in line with the Sprenger court’s requirement of clear and convincing evidence of a transmutation. In Sprenger, the court found that the wife’s mere signature on a stock transfer restriction certificate was not clear and convincing evidence of a transmutation of her husband’s separate stock into community property, especially since the stocks were never issued in her name.
Transmutations Cannot be Conditional
Another contention against transmutation through revocable trusts is that a transmutation cannot be contingent. If an asset can at any time be transferred back into separate property, how can it be said to truly have been indefinitely converted to community property? Further, if the transmutation of separate property to community property is essentially a gift conditioned upon one party’s death, such a conditional interest does not arise to the level of an express delivery of same. This was the Court of Appeals of Tennessee’s reasoning in Burns v. Burns when it held that the placing of a certificate of deposit into both parties’ names for estate planning purposes, but not payable to the husband’s spouse until his death, did not transmute the certificate of deposit into marital property.12
No Reference to Specific Property
There is also an argument that property being transmuted must be specifically set forth in a family trust. Quite often, parties forget or do not get around to actually attaching a schedule that lists what assets are being changed from separate to community. They sometimes rely on broad provisions stating “… all property owned or acquired by the parties …” or similar language. Since clear and convincing evidence is needed to demonstrate that an asset is becoming community property, it is logical to conclude that the specific assets must be inventoried or set forth in the trust. A mere representation that “all of the parties’ assets” are being converted into community property via the trust may be insufficient to meet the burden.
Finally, additional equitable arguments exist in opposition to the transmutation of assets through a revocable family trust. One is that most spouses entering into a trust do so through the assistance of just one attorney who “represents” both spouses. Many times, spouses sign off on these documents with little thought of or explanation by the attorney of the adverse effects. If the spouses later divorce, the spouse whose separate assets were supposedly gifted may allege that he or she believed that the parties were qualifying for a double step-up in basis only when characterizing the property as community. As a result, the legal and economic consequences in the event of a divorce were not adequately explained to them. Such a spouse would allege they entered into the trust blindly and without a real understanding of his or her actions – i.e., without the requisite intent.14 This could also make the trust itself susceptible to an attack similar to an attack on a prenuptial or postnuptial agreement for the same grounds. Another assertion is that a policy in favor of transmutation would be detrimental to married couples obtaining estate planning since a spouse’s attempt to permit the orderly transfer of assets to and best provide for the care of the other spouse could be undermined.
Revocable Family Trusts Qualify as Marital Agreements
A revocable family trust could be considered an enforceable agreement that transmutes property. In Verheyden v. Verheyden, the Nevada Supreme Court held that under NRS 123.220, a writing is required in order to transmute the character of property by clear and convincing evidence.15 A trust is clearly a writing and depending on its content, may evidence a transmutation. Further, it could be argued that revocable family trusts are in fact marital contracts under NRS 123. The statute states that spouses can enter into marriage contracts during the marriage, which can alter their legal rights. Specifically, NRS 123.070 reads as follows:
Either husband or wife may enter into any contract, engagement or transaction with the other, or with any other person respecting property, which either might enter into if unmarried, subject in any contract, engagement or transaction between themselves, to the general rules which control the actions of persons occupying relations of confidence and trust toward each other.16
There is no requirement that contracts under NRS 123.070 take any specific “form,” just that they abide by principles of equity and fair dealing as set forth in case law governing marital agreements. A trust is not a person but rather an agreement – a contract – entered into between spouses formed under a fiduciary relationship with respect to property.17 More specifically, “A trust is a fiduciary relationship with respect to property, arising as a result of a manifestation of intention to create that relationship and subjecting the person who holds title to the property to duties to deal with it for the benefit of charity or for one or more persons, at least one of whom is not the sole trustee.”18 NRS 163.005 states that a trust is enforceable if it meets the requirements for enforcement as a contract. Hence, a trust would apparently fall under the definition of a marital contract since it satisfies the broad definition of NRS 123.070.
Language Sufficient to Evidence a Characterization
There is an argument that as long as a trust expresses a present intent to convert the character of property, a transmutation occurs upon execution. In the case of In re Marriage of Holtemann, the California Court of Appeals dealt with a revocable family trust in which the trust stated that the character of property in the attached schedule of assets “is hereby transmuted from his [husband’s] separate property to the community property of both sides.”19 The court found such a declaration tantamount to an express statement evidencing the parties’ intentions and that the declaration was made and consented to by the spouse whose interest was adversely affected.
While California law does not require the clear and convincing evidence standard that Nevada does in regards to transmutation, it is axiomatic that an express statement of transmutation adopted by the objecting party meets the clear and convincing standard. The court further held that a trust does not have to specifically reference the word “transmutation” in order to create one. Rather, the court only required language sufficient to evidence an intent by the parties to change the character of property. In the similar case of In re Marriage of Lund which also involved a revocable family trust, a transmutation of separate property into community property was found to have occurred via the language “Separate property … is hereby converted to community property …” 20 There was additional language evidencing a transmutation in Lund, such as the declaration that upon the property being converted, each party would have “… equal, existing and present interests therein.”21 This is ironically the same language in NRS 123.225 regarding spouses’ rights in community property.
A Present Transmutation Negates Subsequent Conditions
In Holtemann, the court also took the position that it made no difference on the effect of transmutation if the family trust referenced that the creation of the trust was solely for estate planning purposes. The same conclusion was made in Lund and by the Supreme Court of Idaho in Suchan v. Suchan.22 The Holtemann court reasoned that if there is a present transmutation of property from separate to community, it is final and property cannot be “re-transmuted” without another sufficient declaration re-characterizing the property.23 This would mean that a transmutation also cannot be made contingent upon death. Hence, once property is conveyed via an agreement, it would become an incontrovertible property right since the property must be transmuted in order for the subsequent benefit to take effect.
In Holtemann, the court commented on the husband’s contradictory position that the transmutation was only for estate planning and tax reasons by quoting the trial judge’s findings:
Husband argues that the transmutation was limited to estate purposes only. In other words, Frank wishes to have his cake and eat it too. He argues that, in the event of either his or Barbara’s death, the survivor would be able to use the Transmutation Agreement to claim the property as community property, thus obtaining a full step up in basis to the fair market value of the property at date of death, while at the same time denying the validity of the Transmutation Agreement as an instrument which created community property. Thus, when it would benefit either Frank or his estate, Frank wishes to characterize the property as community. However, when it would be detrimental to Frank, he wishes to ignore the transmutation and call the property separate.24
The trial court was likely moved by the fact that the husband, who once wished, grounded on marital bliss, for both spouses to benefit from the transmutation had changed his position and wanted to dismiss that prior intention in light of the pending divorce. Husband attempted to change his position even though he was previously counseled of the potential consequences prior to executing the trust. If a spouse transferring separate property into a trust in order to benefit from its treatment as community property is informed regarding the effect of same, it is equitable for said spouse to be bound by the after-effects of their bargain. This supposition would have support in Nevada under NRS 47.250(a), which establishes a disputable presumption that “A person intends the ordinary consequences of that person’s voluntary act.”
Estoppel: Finally, there is an argument related to estoppel that may establish transmutation in revocable family trusts. The Nevada Supreme Court, in Anderson v. Anderson, held that where spouses divided up their bank accounts prior to divorce and one spouse led the other to believe the division was permanent, the doctrine of estoppel governed and the funds in the account were transmuted into each party’s separate property.26 Similarly, the position can be taken that a spouse controlling, utilizing or spending an asset for years that was converted via their family trust relied on the representation in the trust to their detriment upon a divorce being filed. The objecting spouse could as a result be barred from taking a contradictory position.
The fact of the matter is that family trusts and divorces do not always mix well. While careful estate planning may be able to avoid the unintentional transmutation of separate property into community in revocable family trusts, divorce attorneys cannot risk assuming such is the case when they come across these trusts. A careful examination and analysis is required in order to determine whether a revocable trust could be deemed to have transmuted property. While Nevada does not address the issue, the arguments for and against the recognition of transmutation through trusts all have merit.
Due to the lack of legal precedent in Nevada on the matter, which argument would prevail upon presentation to a court could depend on the legal arguments as much as the specific fact pattern.
- See also NRS 163.565.
- IRC §1014.
- While not the topic of this article, community property may be also transmuted into separate property through a trust. This is usually done for purposes of protecting property from one spouse’s potential creditors. However, transmuting community property into separate property may deprive spouses of significant tax savings.
- It should be noted that transmutation language in small revocable family trusts is sometimes included unintentionally.
- Sprenger v. Sprenger, 110 Nev. 855, 858, 878 P.2d 284 (1994). It is of note that in Ricks v. Dabney (In re Jane Tiffany Living Trust 2001), 124 Nev. 74, 79, 177 P.3d 1060 (2008), the Nevada Supreme Court stated that clear and convincing evidence must “eliminate any serious or substantial doubt about the correctness of the conclusions to be drawn from the evidence.”
- Cord v. Cord, 98 Nev. 210, 213, 64 P.2d 1026 (1982).
- Said additional evidence could be in the form of a letter from the preparing attorney memorializing the parties’ intentions related to estate planning or tax savings to a noticeable absence in the case of any other documents transmuting separate property into community prior to the trust being formed.
- In re Marriage of Starkman, 129 Cal. App.4th 659, 28 Cal. Rptr.3d 639 (Cal. App. 2005).
- d. at 664.
- In re Marriage of Koester, 73 Cal. App.4th 1032, 1037, 87 Cal. Rptr.2d 76 (Cal. App. 1999).
- Barker v. Barker, 139 Cal. App. 2d, 293 P.2d 85 (Cal. App. 1956).
- Burns v. Burns, 1997 Tenn. App. LEXIS 772 (1997).
- Dahlgren v. First Nat’l Bank, 94 Nev. 387, 580 P.2d 478 (1978).
- In re Marriage of Matthews, 133 Cal. App.4th 624, 35 Cal. Rptr.3d 1 (Cal. App. 2005).
- Verheyden v. Verheyden, 104 Nev. 342, 757 P.2d 1238 (1988). It’s of note though that NRS 123.220 only addresses the transmutation of community property into separate property, although Mullikin v. Jones, 71 Nev. 14, 27, 278 P.2d 876 (1955) holds that separate property can be transmuted into community property. Most courts take the position that writing is required for transmutation either way.
- See also In re Marriage of Holtemann, 166 Cal. App. 4th 1166, 1172, 83 Cal. Rptr. 3d 385 (Cal. App. 2008).
- In re Marriage of Lund, 174 Cal. App. 4th 40, 44, 94 Cal. Rptr. 3d 84 (Cal. App. 2009).
- Restatement (Third) of Trusts § 2.
- In re Marriage of Holtemann, 166 Cal. App. 4th 1166, 1172, 83 Cal. Rptr. 3d 385 (Cal. App. 2008).
- n re Marriage of Lund at 52.
- Id. at 54.
- Suchan v. Suchan, 106 Idaho 654, 682 P.2d 607 (1984).
- In re Marriage of Holtemann at 1173.
- In re Marriage of Holtemann at 1174.
- Anderson v. Anderson, 107 Nev. 570, 816 P.2d 463 (1991).