Our city government informed our pastor a few years ago that it was going to acquire his home in an eminent domain proceeding. Our pastor objected to this, and hired an attorney to fight it. He incurred substantial legal fees in what turned out to be a successful challenge. Now he is asking if the housing allowance designated by our church can be applied to his legal fees. Can they?
Neither the IRS, nor any court, has addressed your question so it is impossible to provide a definitive answer. The closest analogy would be home equity loan repayments made by ministers to a bank or other lender. Some ministers have applied their housing allowance to these repayments. Their rationale is that the loan is secured by a mortgage on their home, and therefore they will lose their home if they fail to make the payments. But the IRS and the Tax Court have rejected this argument on the ground that a housing allowance only can be applied to expenses ministers incur in “providing a home,” and this refers to “direct housing-related expenses” that do not include home equity loan payments unless the loan was secured solely for the purpose of paying for housing expenses.
It is likely that the IRS would use this same logic in evaluating legal fees incurred in stopping a city from seizing a minister’s home using the power of eminent domain. Since the fees are paid to an attorney to avoid loss of a home through eminent domain rather than for the payment of direct, housing-related expenses, it is likely that the IRS and the Tax Court would rule that a housing allowance cannot be applied to the payment of legal fees under these circumstances.
In ruling that a minister could not apply a housing allowance to payments he made on a home equity loan secured by a mortgage on his home, the Tax Court observed:
Exemptions from gross income are to be construed narrowly … and [federal law does not] provide for the exclusion of payments on loans secured by a home if they are not used to “provide a home.” The proceeds of the church loans were used to pay personal expenses of [the pastor and his wife] unrelated to their home. Thus, even assuming that the loans were secured by the [pastor’s home, he has] not shown that the portion of the parsonage allowance used to repay the church loans was used for the maintenance or purchase of the home. On the record before us, we hold that [the pastor and his wife] have not proven that the portion of the parsonage allowance used to repay the church loans was used to provide a home as required by [federal law]. Rasmussen v. Commissioner, T.C. Memo. 1994- 311.