The Great Wealth Transfer Is Here. Have You Divorce-Proofed Your Children’s Inheritance?

August 1, 2022

It is estimated that in the United States over the next 20 years more than $50 trillion in wealth will transfer from the Baby Boomers to Generation X and the Millennials. That is a lot of money. This Great Wealth Transfer is not going to occur just through inheritances when Baby Boomers die. Baby Boomer farmers, business owners, and others with significant wealth or income are also looking to help their kids earlier to buy houses, pay for school, acquire farmland, and build businesses early on and before mom and dad die. That means more and more inter vivos (while alive) gifting will occur in the coming years.

In my divorce practice, I see numerous examples of wealth transfers done wrong. Typically, the gift at issue involves farmland, a cash gift to buy a home, or other large gifts incident to a marriage, or birth of a child. While there’s nothing wrong with gifting wealth to your child and your child’s spouse jointly, people usually don’t see the risk created in doing so—particularly when half of all marriages end in divorce.

The problem usually plays out in some version of the following scenario: Joe and Sue own a large farming operation. They want their son, Beau, to take over the family farm eventually and they want to get him started now. To do that, they gift 80 acres to Beau so he can get started. But Beau is married to Jane. So, Joe and Sue quit claim the 80 acres to Beau and Jane together. Fast-forward 15 years and Jane is unhappy. She’s never been, in her mind, a part of the farming operation and resents the relationship Beau has with his parents. She files for divorce.

Joe and Sue want all of their farm (including the 80 acres they gifted to Beau) to stay in the family. However, since they gifted the land to Beau and Jane together it is now “marital property” in Minnesota, and it will get factored into the divorce. Depending on what else Beau and Jane own, Jane may even end up with it. To avoid this, Joe and Sue could have done some additional planning and documentation on the front end for very little cost. Those efforts would have paid off handsomely in resolving Beau’s divorce.

In Minnesota, for a gift to be valid, the person making the gift must have a donative intent, there must be delivery of the gifted property (for real property, this means delivering a deed transferring the property), and absolute disposition of the property. Donative intent is demonstrated by the surrounding circumstances, including the form of transfer. In the divorce proofing context, the key is to be able to prove the nature of the gift and the intended recipient. Also important is that in Minnesota, the increase in the value of a gift that’s labeled as nonmarital property” through market forces or inflation retains its nonmarital property characteristics. If “marital effort” is expended (such as martial money used to improve the property or if the money is used as general seed money for Beau’s business) then the increase in value is “marital property” and needs to be addressed as such. Here are some options and things to consider in order to protect gifted wealth:

1. Antenuptial and Postnuptial Agreements. The best layer of protecting assets from divorce is an antenuptial (sometimes called a prenuptial agreement or a “prenup”) or a postnuptial agreement. An antenuptial agreement is done before marriage and a postnuptial agreement is completed while the parties are married. Both require significant formality and information sharing. These should not be done without consulting a qualified attorney.

2. Affidavits and Deeds of Gift. Sometimes, we counsel clients to draft an affidavit, which is a signed statement under oath, when they provide a gift of significance and to provide that with the gift. A deed of gift is another tool to prove the gift and the intended recipient.

3. IRS 709 Gift Tax Form. If a gift requires filing a gift tax return with the IRS, we typically advise to provide a copy of the return to the gift recipient to hold in case a divorce occurs. This can be conclusive evidence of the nature and recipient of the gift.

4. Document Everything. If nothing else, keep all other documents you have related to the gift. If the gift was a check for $25,000 to Beau, he should keep a copy of the check. Even better, give the check and write on the memo line “gift to my son Beau.” And Beau should keep all documentation showing what he did with the money. And he’s much better off using that money to buy an asset—preferably an appreciating asset—as opposed to using this nonmarital money to take a trip, pay living expenses, or otherwise spend the money in a way that can’t be accounted for in the property division that will occur as a result of his divorce. If possible, he should keep the money in a separate account and not comingle the funds with other funds or assets.

5. Just Talk it Through With an Attorney. Shameless plug, I know. But I am amazed at the amount of inherited or gifted wealth that gets lost in divorce simply because the donor or the recipient failed to keep proper documentation or obtain it in the first place. Litigating a nonmarital property claim is exponentially more expensive than correctly documenting it in the first place and probably the best investment you can make to ensure that generational wealth can continue to grow and transfer to the next generation.

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