Background. Section 107 of the tax code states that "in the case of a minister of the gospel, gross income does not include … the rental allowance paid to him as part of his compensation, to the extent used by him to rent or provide a home." This language requires very little explanation. The portion of a minister's church-designated housing allowance that is used to pay for housing-related expenses is nontaxable for federal income tax reporting purposes. Stated differently, ministers may exclude from taxable income the lesser of (1) the church-designated housing allowance, or (2) the actual amount of housing-related expenses paid during the year.
Unfortunately, in 1971 the IRS imposed an additional limitation on ministers who own their homes—the nontaxable portion of a church-designated housing allowance may not exceed the annual fair rental value of the minister's home (furnished, plus utilities). Revenue Ruling 71-280. As a result, a housing allowance is nontaxable only to the extent that it is used to pay for housing expenses and does not exceed the annual fair rental value of the minister's home (furnished, plus utilities). The main objective of the fair rental value limit was to prevent ministers who own their homes from receiving a greater tax benefit than those who live in a church-provided parsonage.