When dividing assets during a divorce settlement, a property settlement note is often a useful tool. A Property Settlement Note is a deferred payment of property value used to equalize or distribute assets. A property settlement note is most often used when one of the parties has an ownership interest or significant assets in a business, and a portion of that interest or assets are to be distributed to the other party.
There are 4 key aspects to consider with a property settlement agreement:
- A property settlement note may be used to equalize or distribute assets
- The proceeds from a property settlement note are not taxable to recipient, although interest earned as part of the note payments is taxable to the recipient
- A property settlement note does not survive bankruptcy
- Income from a property settlement agreement must meet certain criteria to be considered “qualifying income” for a mortgage
With a property settlement agreement, the terms and conditions result in a structured settlement, which is a series of smaller payments paid over time, as opposed to a lump-sum payment. Property is still equalized or distributed, but over time. In addition to the structured payments, the recipient normally receives interest to compensate for the delayed payment.
A property settlement note is not taxable to the recipient because the IRS says that the transfer of property in a marriage is not taxable and in this scenario, the property settlement note is still a division of property. However, any interest earned and paid as a term of the property settlement note is taxable income.
A property settlement note does not survive bankruptcy. For example, if the husband owns a business worth $2 million and the wife is receiving a property settlement note of $1 million of the value, the wife may lose her income from the property settlement note if the husband drives the business into the ground and files bankruptcy. When using a property settlement agreement as part of the asset distribution during divorce, the risk of bankruptcy should be considered and addressed through the terms of the property settlement note or other aspects of the divorce settlement agreement.
Income from a property settlement note is not always considered ‘qualifying income’ for a mortgage. If the income from the property settlement note is needed for mortgage qualification, consulting with a mortgage professional (preferable a Certified Divorce Lending Professional) who understands divorce guidelines early on can help make sure that future home financing plans are achievable. Working with a knowledgeable mortgage professional who understands how divorce situations transfer over into mortgage guidelines is key for setting your divorcing clients up for success post divorce.
There are two standard criteria that need to be met in order for income from a Property Settlement Note to be used for mortgage qualifying purposes:
- A copy of the note showing payment terms and proof of continuance for 36 months from the date of closing
- Proof of receipt of payment for the most recent 12 months
If home ownership is among the goals of one or both divorcing parties, a Certified Divorce Lending Professional (such as myself) can help with various portions of the settlement agreement to ensure future home financing goals are achievable, particularly when a property settlement note is part of the equation. Please don’t hesitate to reach out for help and good luck.
Adapted from the Divorce Lending Association