The ministerial housing allowance is the biggest tax benefit available to pastors. It allows you to exclude your housing costs from gross income for your federal income taxes. Thus, all of your housing expenses, from your mortgage payments to your light bulbs, are income tax-free. (You still have to pay self-employment taxes on them, though.)
Ministerial Housing Allowance Limitations
There are nevertheless limits to how much can be excluded with the housing allowance. Your clergy housing allowance is limited to the lesser of:
- the amount actually used to provide or rent a home;
- the fair market rental value of the home (including furnishings, utilities, garage, etc.);
- the amount officially designated (in advance of payment) as a housing allowance; or
- an amount which represents reasonable pay for your services.
While each of these criteria is important, today we are only going to address the fair market rental value of the home, which is the most difficult of the above to calculate.
Calculating Fair Market Rental Value
The IRS does not spell out how they want it calculated, but there are two different methods that the tax courts have allowed people to use when doing so. The first is the comparable fair rental value and the second is the comparable sales method.
Comparable Fair Rental Value Method
The comparable fair rental value is the most common and should be fairly simple if your home is generic. You simply ask, what would a stranger pay to rent your house with all of your furnishings included? A local real estate agent should be able to tell you this. You can also look at rental listings for comparable homes in the local newspaper or from a website like craigslist.com.
For the rental value of your furniture, you could simply add a little extra (be realistic!) or consult with a furniture rental company. However, the rental value that the IRS is interested in is that of the furnished home, not the total of the rental value of the house and the rental value of the furnishings as calculated separately.
Also, it is important that you use local comparisons. Housing costs are significantly different in California and Kentucky, so you need to make your calculations based on your specific real estate market.
Comparable Sales Method
The next method you can use to calculate the fair market rental value of your home is the comparable sales method and it has two steps. The first is to figure out how much your house would be worth if you were to sell it. You can talk to a local real estate agent, check public real estate sales records for comparable homes, or consult a website like zillow.com or redfin.com. Remember, those websites give estimates based on local comparisons, so the more unique your house is, the less accurate their estimates will be.
The second part of the comparable sales method requires you to determine the rate of return on an investment that a stranger would require on a similar property. If a real estate investor came and bought your house from you, what rate of return would they need to make it worthwhile for them? That’s called the capitalization rate.
The capitalization rate will vary based on your local real estate market. Again, your best source for this kind of information is a real estate agent experienced in rental properties. In one tax court decision, the judge applied a capitalization rate of 13%. Because of this, 13% is commonly quoted and used for calculating the fair market rental value for housing allowances.
Be aware, however, that the court case was completely unrelated to the housing allowance. The property in question was used for a gas station, which carries significantly higher risks than a home. Therefore, I would caution against using 13% as a rate of return based solely on the aforementioned court case. A knowledgeable real estate agent will be able to tell you if 13% is a reasonable number for your local market.
Once you’ve determined your home’s sales value and a reasonable capitalization rate, multiply them to get the fair market rental value. For instance, if your home is worth $250,000 and your local capitalization rate is 12%, the fair market rental value that you should use for your housing allowance calculations is $30,000.
Bear in mind that these are rental values for your house and furniture. On top of that, a renter would still have to pay utilities just like you do. So, you would add the cost of utilities to the $30,000 calculated above to arrive at your maximum allowable housing allowance.
Record Keeping & Calculation Frequency
It is important to keep a record of the fair market rental value that you calculated and the method that you used. If the IRS audits you, they may require it to ensure that you did not claim an excessive housing allowance. Without records to back up your claims, they may reassess your tax liability and you would owe both back taxes and penalties.
At this point, you may be thinking: These calculations are time-consuming and tedious. Do I really have to do them every single year?
In an ideal world, yes, you would do them every year. However, even the US Tax Court agrees that it’s a pretty big burden to put on pastors. They had initially ruled in a 2000 court case that it would be too much work for pastors to be forced to calculate the fair market rental value of their homes. However, Congress went ahead and changed the law in 2002 to include the fair market rental value in your housing allowance calculations.
If it’s too much for you to calculate every single year, your second best option is to calculate the fair market rental value every few years. In the years that you don’t calculate it exactly, just increase the amount by the rate of increase in rental prices in your area. So, if the fair market rental value of your home was $24,000 in 2017 and rents went up 4% in your area, then $24,960 would be a fair estimate of the fair market rental value for 2018.
Remember, it is not your church’s responsibility to calculate the fair market rental value of your home or parsonage (for SECA purposes). It is YOUR responsibility. You are the one receiving the tax benefit. I hope this guide makes it a little bit easier for you.
24 Responses
Mike C
April 8, 2019But…it’s the “lesser” of those options listed. So, even if you determine the fair market value is $2,000 a month (like it is in some expensive areas), if you only spend $1,500 on living expenses, you can only claim that $1,500. The other $500 would be taxable. Am I correct?
If so, is it better to leave that cushion or to aim a little lower?
Amy
April 8, 2019Correct, if your actual expenses are less than the fair market rental value of your home then you can only claim your actual expenses. If you had the $2,000 as a designated housing allowance and only spend $1,500, then you would have to add the extra $500 back into your taxable income at the end of the year.
Whether to leave the cushion or lower your designation is a personal choice. If you take a higher designation, then you know all of your expenses will be covered. However, you could end up having to add more back into your taxable income and have a higher tax bill when you file your return.
If you claim a lower housing allowance, then unexpected expenses might not be covered. However, you are less likely to owe more at the end of the year due to having to add in extra income.
There isn’t really a right or wrong answer, you just have decide which you are most comfortable with.
Steve
March 2, 2021What a great article. Thank you. It seems simple enough to calculate the fair rental value of the home, but none of the homes in my area are rented furnished. At one point in the article you said that the IRS isn’t interested in us adding a separate fee for rental furniture. But I’m not sure how to do this otherwise. How much would my TV rent for? I also have some rare, valuable Indian baskets. How much would those rent for? So my question is what is the best way to calculate the cost of furnishings?
Amy
March 2, 2021Steve, you could consult a local furniture rental company or real estate agent. They should be able to tell you about how much the furnishings would increase the rental value. As for rare, valuable baskets, they probably wouldn’t affect the rental value since a stranger likely would not pay more to rent a home because of the baskets.
Steve
March 2, 2021You’re the best at replying! Thanks!
Amy
March 3, 2021You’re welcome!
Anita& Jim Altenbaumer
September 7, 2021We have paid off our mortgage. So am I correct in thinking that we can now use the fair rental value of our home furnished, plus utilities and insurance? I realize that it cannot exceed what Jim gets in his annuity. Just need some confirmation.
Amy
September 10, 2021Anita, your housing allowance is limited to the LESSER of your actual expenses OR the fair market rental value of your home. So, even if the fair market rental value is $24,000, if your qualified expenses were only $10,000, you can only claim a $10,000 housing allowance.
Douglas J
January 1, 2020Does Fair Rental Value include property taxes or can they be added on like insurance and utilities. Home similar to mine in this area rent for $1500 per month. Can I claim the $1500 plus the $1700 property taxes?
Amy
January 1, 2020Douglas,
Property taxes are usually factored in when rents are set and included in the rent. Because they are accounted for with the rental price, you would not be able to add them again. You may want to consult a real estate agent that is familiar with your particular market. Also, remember that the fair market rental value that applies to the housing allowance is for the furnished home, which would be worth more than the unfurnished homes being rented in your area.
Ryan
December 12, 2020Hi Amy, another one for you:
A minister has to make $11k mortgage payments this year, but her fair market rental value for the property is $29k for the year – a difference of $18k.
She has a HELOC open at the same rate as her mortgage. She draws from her HELOC and makes an $18k principle payment on her mortgage.
How much can she count toward her housing allowance this year?
Amy
December 15, 2020Ryan, HELOC funds used for the house do qualify for the housing allowance. However, the housing allowance is designated from a minister’s compensation, so your scenario doesn’t make sense in a lot of situations. For many ministers, the church pays them a set amount and they decide how much they want designated as a housing allowance. For example, if her church paid her $50k a year she could request $11k as a housing allowance and $39k as taxable income or $29k as a housing allowance and $21k as taxable income. In that case, the HELOC would be irrelevant because she would just use her income to pay down the mortgage. If her church is only paying her $11k, she cannot use HELOC funds to increase her housing allowance, because it is limited to her reasonable ministerial compensation. Please let me know if I’m missing something in your question.
RYAN
December 17, 2020Hi Amy, thanks for your reply. I understand if you can’t reply to every comment. I suppose my mentioning of a heloc was a distraction. Here’s maybe a better way of what I’m getting at:
Let’s assume:
1) The church designates 40k of salary as housing allowance.
2) The total, annual mortgage payments, utilities, and other qualified expenses is 20k.
3) The fair rental value, after substaintal increases in property & rental values, is now 30k.
In December, the minister has spent her 20k on housing, but she has the ability to make a 10k principal only payment on the mortgage, which she does.
As I understand it, the ministers housing allowance for that year is 30k.
Here’s the HELOC wrinkle. The minister got the money for that principal payment from a HELOC. She uses the extra tax savings on the 10k to pay down her mortgage and HELOC interest. She makes additional principal payments each year, and has accelerated her mortgage payoff date by accelerating the tax savings of the ministers housing allowance, simply by shifting mortgage debt to HELOC debt.
Amy
December 19, 2020Ryan,
If the church designated $40k as a housing allowance and the fair market rental value is $30k, then there shouldn’t be any problem with her paying $10k towards principal to get her housing expenses up to $30k and having it all qualify for the housing allowance.
Robert Irvine
January 15, 2021I have paid off my house. It is valued at 500K. Do i get any parsonage? Can I still get fair market rental value as a parsonage??
Amy
January 15, 2021Robert, your housing allowance cannot exceed the lesser of fair market rental value, your pastoral compensation, or your actual expenses. With your house paid off, your actual expenses will likely be the lowest of those three amounts and, therefore, what you would claim. Even without a mortgage, you can claim utility expenses, furnishings, etc. This article provides more information on what you can claim: https://pastorswallet.com/what-expenses-qualify-for-the-ministers-housing-allowance/
Tom
March 31, 2022The Church owns the parsonage and as such does not pay property taxes, can you discount the FMV rental rates based on the fact the theoretical ROI includes property taxes.
Amy
April 8, 2022Tom, I don’t think I’ve seen that specifically addressed anywhere. In situations like these, I like to ask myself, “Could I argue this in tax court?” If not, I wouldn’t recommend it. If you feel you can make a good case for it, then it’s up to your discretion.
Becky Frey
October 11, 2023My husband had a gap of 6 months this year. He was employed by church A from January to April and Church B will be from October through December. In factoring housing allowance, is it only for the months he was employed by the churches? I’m not sure if our housing expenses during the months in between employment can count while he was unemployed? In the area we recently moved to, it is a tourist area. If we were to rent our home on air bnb per night it would probably go for $200 a night. Is it ok to use this reasoning for the fair rental value?
Also, I read an article that gave the following example for Fair rental value. Can you tell me if this is accurate?
Example A:
Pastor Dan and his wife own their 6 room home. They pay their own utilities ($2,700), insurance ($650), maintenance & repairs ($1,200) and real estate taxes ($3,500). They also have a mortgage and pay $1,050 per month for principal and interest ($12,500).
A total out of pocket cost to own and maintain the house is $20,650 for the year. They have furnishings and appliances in the home that have a replacement value of $25,000.
They ask a local realtor provide to provide them with local comparisons for a totally furnished like property would rent for in their community. (Comment: a landlord who was renting this totally furnished property would be looking to make an annual profit of at least 20% over cost.)
Total Annual Cost of Home: $20,650
20% of Replacement Cost of Furnishings: 5,000
Total Annual Cost of Home & Furnishings: $25,650
Landlord’s profit if it were Rented (20% of Annual Cost): 5,130
Fair Rental Value including Utilities & Furnishings: $30, 780
Amy
October 11, 2023Becky, a gap in employment is not specifically addressed by current IRS rules. The timeframe for using housing allowance funds is within the tax year. For example, housing allowance that is paid out in January can be used for expenses in December. Based on that, I would think it would be okay to use housing allowance funds from Church A during the gap. Funds can only be used proactively and not retroactively, so funds from Church B would not be available to use during the gap since they hadn’t been paid yet.
I would not use AirBnB rental values for Fair Market Rental Value (FMRV) because there is a big difference between long-term and vacation rentals. When the IRS says FMRV, they are thinking of long-term rentals, as if you were renting the home yourself.
The IRS does not specify how to calculate FMRV. Basically, they accept any logical, reasonable approach. I don’t know how accurate the 20% return for the landlord is, but that seems like a logical and systematic approach, so I would be comfortable using it.
Walter
November 24, 2023About “Fair Market Rental Value.”
I am about a year away from retirement. We can no longer afford our dream home. As a “Plan B,” we are considering living in a 55+ Mobile Home Gated Community. Using a real example, there is a mobile home currently listed for $295,000. Zillow has its “Rent Zestimate” as $1,189.00/MO. The Lot Fee is $850.00. What numbers are added to report to the IRS as “Fair Market Rental Value?” Is only the first item to be considered? I can find nothing on the “Zestimate,” to see if that includes furnishings. I take it that taxes and insurance are not to be included.
Amy
November 29, 2023Walter, the fair market rental value will include the “Rent Zestimate,” utilities, and some amount that would represent the value of your furnishings. That assumes that the lot fee is included in the “Rent Zestimate.” You could ask someone at the community how much it would likely rent for and use that instead of the “Zestimate”/lot fee. The “Zestimate” is likely the rental price for the empty home, so you can increase it by utilities and furnishings.
I also want to say that my mom was in the exact same position as you and she absolutely loves living in her 55+ community, so your “Plan B” could be a blessing in disguise like it was for her.