How do I calculate the Fair Rental Value of my home used to determine my Housing Allowance exclusion?
Fair Rental Value (FRV) is important to establish when a minister is provided a parsonage or housing allowance. When a pastor is provided a parsonage, the fair rental value he reports is subject to SECA tax (social security and Medicare). The fair rental value is also a factor in the three part test used to determine how much a pastor can exclude as housing allowance. IRS Publication 517 (Jan 2020) describes that under the three part test, a minister "may exclude from gross income the smallest of 1) the amount actually used to provide a home, 2) the amount officially designated as a housing allowance, or 3) the fair rental value of the home, including furnishings, utilities, garage, etc."
Because fair rental value is needed both when a minister has a parsonage and a housing allowance MinistryCPA often receives questions regarding its calculation. Furthermore, the IRS does not provide clear guidance on this issue. The IRS Ministers Audit Techniques Guide (April 2009) simply states that "determining the fair rental value is a question of all facts and circumstances based on the local market." It is important to note that the fair rental value is of the furnished home, and includes utilities.
There are a several ways in which the fair rental value of a home might be determined.
One relatively simple way to estimate fair rental value is by using Zillow or another similar website. For most homes, Zillow provides an estimate of both the fair rental value and total market value of the home. When using one of these estimates it is still important to consider whether the value is reasonable and accurate. Further, these estimates do not anticipate additional fair rental value for furnishings and for utilities.
A second way of calculating fair rental value is based on the home's assessed or appraised value. This value can be taken from a recent real estate tax bill or appraisal, and multiplied by an estimated multiplier or rate. A reasonable rate is typically between 8-15%. The low and high end of this range reflects communities that have generally below or above national market rental rates. For example, assume the assessed value of the home is $200,000. Using 10% as a multiplier, the fair rental value is $20,000 per year.
A third alternative is to base fair rental value on a realtor's informal opinion, which often provides a range of potential values. Some people even recommend hiring a local real estate appraiser to provide an official appraisal, which is typically costly. We believe these options to be unnecessary in most situations.
Whichever method is used to calculate fair rental value, it is important that good, clear documentation is kept. Ultimately the fair rental value should be both reasonable and comparable to similar homes in the community.