Whether you’re writing a will or getting divorced, an inheritance is your separate property if you live in one of eight community property states: Wisconsin, Washington, Texas, New Mexico, Nevada, Idaho, California or Arizona. The inheritance is yours to do with as you please. You can liquidate it and invest it, sell it or bequeath it to whomever you choose. But there are a few caveats.
Separate Income Versus Community Income
According to the Internal Revenue Service, income produced by separately owned property, such as property you inherited, is your sole income. Community income is anything earned through wages, salaries or from performing some labor or service; it results from your time and effort. Passive income, or anything accumulated without your active participation, generally is not community income. But in Texas, Louisiana, Idaho and Wisconsin, this law is not clear-cut, so you’ll need to take steps to protect yourself.
Commingling With Community Property
Income produced by your inherited property can become community income if you don’t keep the money separate from marital funds. You’re not obligated to deposit the income into a jointly-held account or use it toward a marital asset, and you shouldn’t if you want to preserve the income as separate property. As soon as you use the money toward the marital community, it becomes community property. This can be true for something as simple as using it to pay for a vacation you and your partner take together.
Using Marital Funds
You risk losing not only the income, but some portion of the property itself, if you use community funds toward the property's upkeep, maintenance or repair. This is especially true in Texas. Ideally, you should take all income produced by your inheritance and place it in an account in your sole name. Pay all taxes and other expenses incurred by ownership of the property out of that account. Don't put any marital funds into the account if it runs short, such as your paycheck. If you do, you’ve “contaminated” the account, the income and potentially the property as separate assets.
Most common law states -- as opposed to community property states -- also treat inheritances as separate property, and they are safe from distribution in a divorce. Wherever you live, always keep a clear “paper trail” of all transactions regarding your inheritance. If your spouse makes a claim for it, you can show when it was received, what you did with it and that no marital money was used in association with it. You can also draft a prenup, or a post-nuptial agreement if you inherit after you’re married, in which your spouse relinquishes any rights to the property or the income produced by it.