Article on Texas Exceptions for Partnership Interests in Community Property

Nikki L. Laing recently published an Article entitled, Planner Beware: A Peculiar Exception to Texas Community Property Rules, 8 Est. Plan. & Community Prop. L.J. 423 (2016). Provided below is a summary of the Article:

So, you think you know Texas community property law? How about a quick illustration to test your knowledge of the basic rules? Suppose you invested in ten city lots before you married your spouse. Under Texas community property law, the lots would be characterized as your separate property because they were acquired prior to marriage. During your marriage, you decide to sell one of the ten lots and invest the proceeds in a different asset, such as rural real estate. According to Texas community property law, the cash you receive from the sale of your city lot is your separate property, including any portion of the proceeds which represents an increase in the lot’s value that occurred during your marriage.

The same set of principles would apply if you decided to extract capital from an entity that is your separate property and invest the extracted capital in a different asset–right? Not necessarily! Texas courts have held that a return of investment from a separate-property partnership interest is community property. This peculiar departure from traditional Texas community property rules, as well as other alarming exceptions discussed in this article, requires careful planning by investors and business owners and their advisors.

Estate, business, and asset protection planners alike should be aware of the exceptions and inconsistencies that exist in the treatment of partnership interests. Whether a client is considering investing separate property in a partnership, making a distribution from a partnership, or giving a partnership interest to a child with the expectation that it will remain the child’s separate property, the advisor should warn the client of the risks involved. This article examines some curious deviations from traditional Texas community property rules that exist and discusses why these rules should apply consistently to partnership interests held as separate property.