For many clergy members, the housing exclusion is one of the most significant tax benefits available. The Internal Revenue Code (IRC) §107 provides a special exclusion that allows ministers to exclude the value of housing provided by their church or a designated housing allowance from their gross income. However, as with most things in the tax world, the details are where things get complicated.
What Is the Housing Exclusion?
The housing exclusion allows clergy members to exclude from their taxable income the rental value of a home furnished to them as part of their compensation or a rental allowance paid to them. This exclusion applies only to income taxes—not to self-employment taxes. The law is designed to acknowledge the unique role clergy members play, often being bound to their employers with limited freedom to move, especially in areas where housing costs are high.
The Legal Foundation: IRC §107
Under IRC §107, the law specifically states that "in the case of the minister of the gospel, gross income does not include:
(1) the rental value of a home furnished for him as part of his compensation; or
(2) the rental allowance paid to him as part of his compensation,
to the extent used by him to rent or provide a home and to the extent such allowance does not exceed the fair value rental value of the home including furnishings and appurtenances such as a garage plus the cost of utilities."
This provision is clear: clergy members can exclude from income either the rental value of a home provided by their church or a cash allowance designated for housing, provided it does not exceed the actual expenses or the fair rental value of the home.
Who Qualifies for the Exclusion?
A clergy member must be a “duly ordained, commissioned, or licensed minister of a church or a member of a religious order.”
Revenue Ruling 59-270 does identify some individuals who were not considered clergy members for the housing benefit. This includes ministers of music and ministers of education as “Neither of them is an ordained minister of the gospel, although they are both performing services relating to the office and functions of a minister of the gospel.”
Additionally, theological students often have required internships with a parsonage allowance however these allowances cannot be excluded. Only individuals ordained, commissioned, or licensed as a minister can exclude a housing allowance/parsonage.
How the Exclusion Works
The housing exclusion can take two forms:
Housing Provided by the Church (Parsonage): If a religious organization provides a clergy member with housing (commonly referred to as a parsonage), the fair rental value of that housing, along with associated expenses like utilities, can be excluded from the clergy member's gross income.
Housing Allowance: If the church provides a cash allowance instead of a parsonage, the clergy member can exclude that allowance from income, but only up to the amount actually spent on housing-related expenses such as rent, mortgage interest, utilities, and home maintenance. The allowance must be formally designated as such in advance—whether in an employment contract, church resolution, or budget—and must be separate from the clergy member's salary.
Restrictions and Requirements
It's important to note that the housing exclusion is not unlimited. The exclusion cannot exceed:
- The amount officially designated by the church,
- The actual expenses incurred for housing,
- The fair rental value of the home (including furnishings and utilities),
- Or the clergy member’s reasonable compensation.
Any amount exceeding these limits must be included in gross income. Additionally, the housing exclusion applies only to one home. Attempts to apply the exclusion to multiple residences, such as a second home or vacation property, have been struck down in court, as seen in cases like Commissioner v. Driscoll.
What Expenses Can Be Excluded?
The types of expenses that can be excluded from income under the housing allowance are fairly broad, including:
- Rent or mortgage payments,
- Utilities (electricity, gas, water, etc.),
- Property insurance,
- Repairs and maintenance,
- Furnishings.
Even though the housing allowance can cover a wide range of expenses, it’s essential to keep meticulous records. The IRS expects documentation that justifies the exclusion, and failing to provide it can result in the allowance being added back to taxable income.
Self-Employment Taxes Still Apply
One key point to remember is that while the housing exclusion is not subject to federal income taxes, it does not reduce the income subject to self-employment taxes under SECA. Clergy members must still calculate their Social Security and Medicare taxes based on their total income, including the value of the housing provided or the housing allowance received.
It is important to keep in mind that because it is included for Social Security and Medicare purposes, the housing allowance does count as earned income for purposes of calculating the earned income credit.
Key Points to Remember
The housing exclusion under IRC §107 offers a significant tax break to clergy members, recognizing the often unique and challenging circumstances they face. However, this benefit comes with specific rules and limitations that must be carefully navigated. For clergy members, understanding these rules—and working with a tax professional familiar with clergy-specific tax issues—is crucial to maximizing the benefit while remaining compliant with tax laws.
When used correctly, the housing exclusion can substantially reduce a clergy member’s taxable income, allowing them to focus more on their ministry and less on their tax bill. But as with all things tax-related, the devil is in the details, and getting those details right is essential.
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