Lately, I’ve seen people recommend that pastors who have paid off their mortgages should take out home equity lines of credit (HELOCs) to extend their housing allowance. The idea is that without a mortgage you cannot claim as much in housing allowance so taking on new debt related to your home will allow you to increase your housing allowance and save on taxes.
That is not a good idea. First of all, depending on the interest rate on your HELOC, you may not save any money. Secondly, debt reduces your flexibility and adds greater risk to your financial situation.
HELOC Eligibility For Clergy Housing Allowance
Finally, and most importantly, debt is only eligible for the clergy housing allowance if it is used for eligible home expenses. Just because a HELOC is tied to your home equity does not mean it automatically qualifies for the housing allowance. As with a cash-out refinance, the debt payments are only eligible for the housing allowance in as much as the funds were used for the home.
If you open a HELOC and use the money for a vacation, college, to pay off debt, or to invest, your HELOC payments are not eligible for the clergy housing allowance. If you use the money to pay for a new roof or build a deck or swimming pool, then it is eligible for the housing allowance.
Keeping Taxes In Their Rightful Place
One important principle in financial planning is to never let taxes take the lead on your decisions. Once you’ve made a decision, by all means, optimize for taxes and do tax planning. But never lead with taxes. For example, if you’re moving, instead of finding the lowest tax county in the lowest tax state and moving there, decide where you want to live based on your family, job, and lifestyle preferences and only then take taxes into consideration as you choose your house.
There are more important things in life than just saving money on taxes, so you should optimize for your specific life before optimizing for taxes. Because of this, I would never recommend that someone take on debt just to save on taxes. If you have a goal in mind that requires a HELOC then it might make sense to take one on, but don’t do it just for tax savings.
In summary, HELOC payments are only eligible for the minister’s housing allowance if the money was actually used for eligible home-related expenses. And don’t make decisions based on the tax consequences. Make your financial decisions based on what is best for you and your family and only then think about taxes.
9 Responses
Tim
April 29, 2024Interest rates now make the strategy less desirable anyway, but if it were 2020 rates and a pastor did a cash out refinance of a $300,000 house and proceeded to take section 107 distributions of their $300,000 403b over a 10 year span, they would be roughly back in the same place only with $300k non-qualified instead of pre-tax dollars. This is an extreme example for sure, and not a HELOC. Also, mortgage fees and interest compared to the taxes saved may not be that significant other than the very rare cases where a retired pastor is in a high tax bracket. And assuming the pastor lives long enough, they may be able to get the entire thing out tax free anyway.
Douglas J
April 29, 2024I agree that taxes should not lead the decision. My CPA reminded me that income is not 100% taxable, but interest applies to the entire loan. Here is where a HELOC might make sense. If my RMD from my 403(b) is $15,000,but I only need $5000 for expenses, I might decide to remodel the kitchen and bathroom with the remaining $10,000. However, the remodel will cost $20,000. I might opt to get a HELOC for $10,000 to carry that expense into the next year so that my RMD can become a parsonage expense. Is that a legitimate use of a HELOC? How would I account for that payment as a parsonage expense next year?
Amy
April 30, 2024Home remodels are definitely eligible for the clergy housing allowance. Of course, I would only do the remodel if you actually wanted to and not just to get funds out of your 403(b) tax free, since the remodel is more expensive than the taxes would be. Your example sounds legitimate. You can use a HELOC for some of your expenses and then pay it off the following year in order for it to count towards the housing allowance in the following year. Paying off the HELOC would be considered an eligible expense just like paying off your mortgage would be.
Jason
April 30, 2024So, imagine these two scenarios.
Scenario 1: You finish paying off your mortgage and then you sell your house and buy another equally priced house and move into it, but finance the entire amount (even though you could have paid it off immediately).
Scenario 2: You refinance your home and take out cash equal to the amount of your mortgage that was never previously applied to the tax deductible pastoral housing expenses.
The second scenario actually seems more in the spirit of the law as it would make it possible for the government to give a tax deduction for the full value of the home you live in. The first scenario could be repeated endlessly making the government give a tax deduction for an infinite number of homes.
Thoughts?
Amy
May 7, 2024Scenario 1 is legal, though I believe it is unlikely that someone would do it just for the tax savings. Selling a home has significant transaction costs so you would need to subtract them from any tax savings you receive. Also, buying, selling, and moving is a tedious and exhausting process that costs a lot in time and emotional energy, which may not be as quantifiable but is just as real. Then you also have the cost of the interest you are paying on the mortgage.
Scenario 2 is not legal because the housing allowance cannot be retroactive. You cannot pay yourself back for a housing allowance you could have previously taken but didn’t.
When it comes to your financial life and the clergy housing allowance, the housing allowance is the icing on the cake but not the cake itself. If you forget the cake and only go for the icing, you’ll make yourself sick.
Randall
May 25, 2024I have read your recent articles regarding utilizing a home equity loan to finance renovations and other. My question is could the home equity loan be utilized to purchase the lot that I will build my next home in retirement. I will soon have RMD’s and will be moving and making the purchase anyway, so it’s not making the tax savings the primary issue. However, before doing so I wanted your opinion. I am a retired minister with 403b savings and soon to begin distributions.
Amy
May 26, 2024Randall, your questions isn’t addressed specifically by the IRS. However, they have determined that you can only claim the housing allowance on 1 home at a time, so I think using it for your current home while also a new lot would violate that.
Randall
May 27, 2024Dear Amy – thank you for your helpful response. Here’s another question. My wife is also a licensed minister who can receive a housing allowance. I have read that the IRS considers each of us separately regarding the housing allowance (although we live together). Since we live in the same home – Would you perceive it within the guidelines for her to claim the expenses our our current home in Alabama for her housing exception and for me to claim my housing allowance on the property we hope to purchase in Arkansas (I realize that we would still fall under the same rules that govern the housing allowance – amount employer sets aside, real costs, and fair rental value). Would we have the same problem only one home at a time) if both used the equity on the Alabama home? If that is the problem I could easily finance it separately.
Amy
May 28, 2024That’s a really good question. The IRS does not specifically address that situation anywhere. I could think of good arguments both in favor and against it, so I am not comfortable picking a side in this situation. The safe answer is to only pick one house, but ultimately it is your decision and your judgment call. Sorry I don’t have a better answer!