January 10, 2014

Effect of Mortgage Prepayment on Housing Allowance

Question:

Can a minister pay off his mortgage early and prorate the prepayment each year over the life of the original loan, essentially treating what he would have paid each year as a housing allowance designation?

Answer:

Individual taxpayers are on a strict cash basis of accounting, so tax deductions are only allowed for cash payments made during a given year. Additionally, the housing allowance deduction is limited to the least of three amounts:

(a) the amount actually used to provide a home,
(b) the amount officially designated as a housing allowance, or
(c) the fair rental value of the home.
(Sources: IRS Publication 1828; Clergy Housing Allowance Clarification Act of 2002; IRS Regulation Section 1.107-1)

Based on this list, a minister who owns his home and makes no housing payment in a given year will be eligible for a housing allowance deduction only to the extent of current-year cash expenditures. Further, in the year of significant prepayment, it is likely that the fair rental limitation will apply since his total actual expenditures will exceed fair rental value.

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