Jeff Palmberg faced a dilemma.
The veteran youth pastor had been called to a new church near Seattle, a great opportunity for him and his family. The congregation welcomed them with open arms and wanted them to live near the church.
But housing prices in the community were beyond the pastor’s means. Even a modest home could cost more than $800,000. So, the church offered to help—lending Palmberg enough money for a down payment on a home his family could afford.
That kind of sticker shock is not uncommon for pastors, said CPA Rob Faulk, a partner with CapinCrouse, especially in major cities or other high-priced areas. In response, sometimes the church loans the pastor money for a down payment, while in other cases the church and pastor own the property together. Such arrangements can seem especially appealing right now: housing prices in most markets continue to climb nationwide, and the constitutionality of the housing allowance benefit for ministers remains a question mark, due to ongoing court challenges.
But both loans and co-owner partnerships require caution. Such arrangements can be risky, said Faulk and Frank Sommerville, an attorney, CPA, and editorial advisor for Church Finance Today.
We recently spoke with Faulk and Sommerville about how loans and co-owner partnerships can work—and the challenges churches and pastors face with both approaches.
Why would pastors and churches consider purchasing a home together as a joint investment or some kind of joint ownership?
Sommerville: In certain high-income areas, churches cannot or will not pay a sufficient amount of salary to allow that pastor to buy a home in the community. So, you have this disconnect between the church’s desire, the cost of living, and the pastor’s finances. We’ve seen it most in major metropolitan areas like Chicago, New York, Silicon Valley, and similar areas. We offered legal guidance recently for a church in a community where the lowest priced home for sale was $1.6 million.
The church could buy a home to use as a parsonage—but that can backfire on the pastor. For many pastors, one of their largest assets when they retire is their home. If they are in a parsonage, they don’t benefit when the property appreciates and they have no place to go when their employment ends. So, they’d prefer to own a home. But in some cases, the economics don’t work.
Faulk: California is another area where pastors have had that sticker-shock problem. I have seen cases where a church will, in essence, lend the pastor the funds for a down payment and the pastor will then go out and get a mortgage. I’ve also seen churches that are willing to co-invest with a pastor. So, if a home costs $300,000 for example, the pastor may put up $100,000 and the church will put up the rest. In that case, the pastor would own a third of the house—and the church owns two-thirds.
Is there a written contract for this kind of arrangement?
Faulk: Usually there’s an agreement that lays out the terms. For instance, if there is a loan involved, an agreement could give a reasonable interest rate. This could keep the loan from being seen by the IRS as excess compensation. A loan agreement will have repayment terms. It will also address issues like, what happens if the pastor’s employment ends? How much time does a pastor have to sell the house if that happens?
In some cases, I’ve seen a church forgive the loan over time. We have a client where the church loaned a pastor $300,000 and they are forgiving that loan over a 10-year period. So that’s not atypical.
But these arrangements do come with some challenges and concerns.
What are some of those challenges and concerns?
Sommerville: The concern is that none of these ideas work in most cases. The IRS has taken the position that any loan a nonprofit makes has to meet all commercially reasonable underwriting standards. Otherwise, the whole amount of the loan is considered an excess benefit transaction, subject to IRS sanctions.
So, if a church is helping a pastor out with a loan, it needs to do a credit check, inspect the house, check with other lenders to see if those lenders would make a loan under the same terms the church is offering. If a third-party lender is willing to make the loan—why should the church be involved?
If the loan is forgiven, that can be problematic. That’s not a commercially viable term. I am aware of an audit where a loan like that was considered taxable from day one.
Is there a way for a church to do this that won’t cause trouble with the IRS?
Sommerville: There’s a little more hope on the co-investing side, sometimes referred to as a co-venture. The church essentially forms a limited purpose partnership with the pastor and the partnership owns the home. But some of the same problems come up. If both sides are willing to put up money, the church could do a co-venture on the ownership of the house. But a church can’t do a co-venture unless it remains in ultimate control of the property.
The church has to have full control of the property—which the pastor may not agree with.
You can also run into risk-management problems. In Southern California, a pastor was terminated—and ended up owing the church $300,000 on the house. In the end, no one was happy. The pastor was unemployed. And the church didn’t want to have to sue the pastor for the $300,000 they were entitled to. If they forgave the $300,000, that would become taxable income.
Also, if you have a co-venture, you’ve got to have a solid agreement that spells out all the details. That includes maintenance or improvements to the home—who pays? Does the church need to approve any changes? And what happens if a pastor is terminated? What happens if a pastor leaves? What happens if the property goes up in value? What happens if the property value goes down?
And when you have a co-venture, there’s not a third-party mortgage company that will touch that arrangement as a home loan. So, you’re generally looking at all-cash deals.
Faulk: Sommerville raises a lot of good points that many churches haven’t thought through. Any church that goes into this needs to get legal counsel. Most churches don’t have the knowledge and training to enter into these agreements without counsel.
What about taxes related to co-ownership?
Sommerville: If there’s joint ownership, then taxes could a problem. In Texas, for example, a church claimed a parsonage exemption for a house they owned with the pastor. A local appraisal official, who happened to be a member of the church, found out—and all of a sudden, the pastor had to go back and pay years of property taxes. The church was listed on public records as owning the house—but legally they weren’t the sole owner.
My recommendation is that churches should not do this because the risks are disproportionate to the benefits.
I know that colleges and hospitals often help professors or doctors buy a home in their communities. Why are these entities able to do that but churches are not?
Sommerville: Faulk and I have talked a lot about that. Colleges and hospitals do these kinds of arrangements all the time. Doctors and professors aren’t what the IRS considers a “disqualified person” in relationship to the hospital or college. But a pastor is a “disqualified person,” meaning the pastor possesses sufficient decision-making control that it becomes a conflict of interest for arrangements that will benefit him or her. The risk matrix is very different in the church world.
Faulk: Just to clarify, I would say that some pastors would not be disqualified persons if they are not in a position to influence the church’s overall policies. For instance, a senior pastor would certainly be a disqualified person, as would an executive pastor. But a youth pastor might not be considered a disqualified person. It likely depends on the facts and circumstances.
Have either of you seen a co-investment arrangement work?
Faulk: I’ve got situations where both the senior pastor and the executive pastor had these deals and it worked well. Both pastors sold their houses. And there was a gain on the house in both cases, so these pastors shared the gains with their church, and everyone was happy. But neither was a situation where someone was asked to step down. Both were happy endings. But that doesn’t mean the risk wasn’t there.
Are these arrangements only used by churches in high-cost areas?
Sommerville: It’s mostly been in high-cost areas. What we’ve seen in rural churches is that they’ll give the pastor a signing bonus of $10,000 or $20,000, and that is usually more than enough to allow them to purchase a home—and still qualify as reasonable compensation.
Is there a best-case scenario for a joint investment or other kinds of partnerships between a church and a pastor in owning a house?
Sommerville: The best-case scenario I would say is that the property value goes up and the house is easy to sell. And if the pastor does leave the church, it is on friendly terms.
The second-best situation is that the house value goes up, the pastor exercises their option to buy, and everyone walks away happy. But I’ve rarely seen these deals work out best for everyone.
Of course, there is always the problem of the IRS looking into these types of arrangements. I don’t think it’s worth the risk.
Are there other alternatives that a church should consider?
Sommerville: One arrangement we use on a regular basis is an option-to-buy agreement. The church buys a house that the pastor wants—and the pastor buys an option to purchase the house for the same price the church paid for it at some time in the future.
Now the pastor has to pay fair-market value—which depends on how long the option to buy lasts. The option-to-buy might be for 10 years or 15 years and the pastor can exercise the option as long as he or she is still employed at the church. If you’ve got an appreciating market, the appreciation is going to be sufficient to allow him to purchase the property without a down payment. And if the pastor is successful at the church, hopefully his or her income will go up, making it easier for the pastor to get a mortgage. We’ve been doing this for about 10 years and about 20 percent of the time, we’ve seen the pastor exercise their option to buy.
Another possibility: a church can set aside some money every year for the pastor’s retirement, which can help with future housing. I’ve seen a church—when a pastor left—give a lump sum that could be used for a down payment on a home.
Editor’s note: For further information on saving for retirement, see “Helping Your Pastor Build Home Equity.”