If you are an ordained, commissioned, or licensed minister, you are performing ministerial services for your church, and your church designates part of your pay as a housing allowance, you may be able to leave some of it out of your income for federal income tax. How much is limited by the smallest of three numbers. This guide explains each number in plain terms and how to keep track of all three.
This is educational information, not tax advice. Rules have exceptions and change over time. Confirm your situation with a qualified CPA, EA, or attorney, and see IRS Publication 517.
Full disclaimerThe short version
IRS Publication 517 says the exclusion cannot be more than the smallest of:
- The amount officially designated as a housing allowance by your church.
- The amount you actually used to provide a home.
- The fair rental value of the home, including furnishings, utilities, garage, and so on.
Whichever of those three is lowest is your ceiling. If you spent less than the other two, your actual spending is the limit. If your church designated less than you spent, the designation is the limit. If the fair rental value comes in lower than both, that is the limit.
Two more points from the same publication are worth knowing:
- The housing exclusion applies only for income tax purposes. It does not apply for self-employment tax, and ministers generally include the housing amount when figuring net earnings for self-employment tax.
- Any part of the allowance that is more than the smallest of the three must be included in gross income. Publication 517 explains how to report that on Form 1040.
An example with made-up numbers
Here is an illustration, not a suggestion of what anyone's numbers should be.
| Number | Amount |
|---|---|
| Designated by the church | $25,200 |
| Actual housing expenses for the year | $23,293 |
| Fair rental value, furnished, plus utilities | $28,877 |
The smallest of the three is the actual expenses, $23,293. In this example that would be the ceiling, even though the church designated more and the fair rental value is higher. Your own numbers will differ, and how the rule applies to you is a question for your CPA.
Number 1: the designation
The church must officially designate the payment as a housing allowance before it makes the payment, and it must designate a definite amount. It cannot decide the amount at a later date. Publication 517 says the designation can be shown in an employment contract, in the minutes of the church, in a budget, or in another official action taken in advance of payment. Informal discussions do not count.
In practice that usually means a written resolution recorded in the minutes. Our guide on designating your housing allowance for next year walks through the steps, and there is a free sample resolution you can edit.
Keep: a copy of the written designation for each year.
Number 2: actual housing expenses
These are the amounts you actually used to provide your home. Commonly counted costs include rent or mortgage payments, property taxes, homeowners or renters insurance, utilities, repairs and maintenance, and furnishings. Costs that are not really the cost of providing a home, such as food and household help, are generally not counted. Some items are debatable, and that is what your CPA is for.
Keep: receipts, bills, and bank or mortgage statements, categorized through the year. This is exactly what the ledger and receipt capture in Housing Allowance Helper are for.
Number 3: fair rental value
This is the one people guess at. It is an estimate of what your home, furnished, would rent for, including utilities. It applies whether you own or rent. Publication 517 defines it but does not lay out a step-by-step formula, so the practical goal is an estimate you can explain. Our guide to fair rental value for clergy covers what goes into one.
Keep: a written estimate with your reasoning and the comparables you used, refreshed if your home or the market changes materially.
Other things worth knowing
- Self-employment tax. Ministers are generally treated as self-employed for Social Security and Medicare purposes on their ministerial pay, even when the church issues a W-2. The full housing amount counts toward that tax, which is why many ministers make quarterly estimated payments. A minister who has an approved exemption is the exception. Ask your CPA which applies to you.
- Mortgage interest and property taxes. Section 265(a)(6) of the Internal Revenue Code lets a minister who itemizes deduct home mortgage interest and real estate taxes even when those costs were paid with tax-free housing allowance. Ask your CPA how it applies to you.
- Reasonable pay. The exclusion applies to pay for ministerial services, and total compensation is expected to be reasonable for the work done.
- State taxes. This guide is about federal income tax. States treat the allowance differently, so check your state's rules.
Putting it together
At year-end you or your preparer compare the three numbers and take the smallest as the ceiling. A tidy record of all three, meaning the designation, the expense total, and the fair rental value write-up, turns that into a short task instead of a weekend. The year-end checklist lists what to hand your preparer.
Checklist
- Written designation on file, adopted before the payments it covers
- Every housing expense logged and categorized, receipts attached
- A current fair rental value estimate with comparables and reasoning
- Utilities totaled separately
- All three saved somewhere you can export and send
Sources: IRS Publication 517 (opens in a new tab), Social Security and Other Information for Members of the Clergy and Religious Workers; Internal Revenue Code section 107.