The Harm in Renting Out the Church Parsonage
We often work with churches that have a parsonage going unused or rented out to non-members. As such, the question arises as to tax liabilities. The primary concern is either Property Taxes or Unrelated Business Income Tax.
Parsonage Property Taxes:
A residential property, (parsonage) owned by the church and being leased does affect the property tax exemption, namely the religious exemption. However, the parsonage may still quality under a welfare exemption. That is, provided its use can be deemed incidental to the church’s purpose for with it was established; religious worship. It does not need to be adjacent to or on the church site.
As far as the California Board of Equalization is concerned, the issue lies in the use being incidental to and reasonably necessary for the religious purpose of the church. Provided that is the case, most scenarios will permit at least its partial exemption for property taxes. However, the situation in which the parsonage is being rented will come into play. These include, but are not limited to who lives there, for how long, and how much rent is received.
However, there is no hard and fast rule to apply. Once the pastor ceases to live in the parsonage, the tax exemption will be in jeopardy. The argument here is that once the parsonage is rented out to a third party, its income is not reasonably necessary for and primarily used and devoted to the purposes of the church. This is because it can be difficult to show that a house being rented out and not used in any way for religious purpose is reasonably necessary for religious worship.
Incidental To And Reasonably Necessary:
With respect to employee housing provided by qualified organizations, the Legislature enacted section 214(i) in 1988, as “declaratory of existing law”, referencing longstanding judicial precedent on this issue. Section 214(i) states in relevant part that:
Property used exclusively for housing and related facilities for employees … shall be deemed to be within the exemption … to the extent the residential use of the property is institutionally necessary for the operation of the organization.
Thus, the statute provides that property used for employee housing will be exempt if it is institutionally necessary for the operation of the organization.
In 1999, the Board of Equalization adopted Property Tax Rule 137, Application of the Welfare Exemption to Property Used For Housing. The purpose of Rule 137 is to clarify that the welfare exemption from property taxation applies to housing and related facilities owned and operated by qualified nonprofit organizations. Additionally, to establish a single uniform statewide standard for determining qualification for the welfare exemption as it applies to such properties.
Rule 137 provides the following guidance for applying the welfare exemption to housing:
Housing and related facilities owned and used by community chests, funds, foundations or corporations organized and operated for religious, hospital, scientific or charitable purposes is eligible for the welfare exemption from property taxation as provided in Revenue and Taxation Code section 214. A single uniform statewide standard shall be used to determine whether the welfare exemption applies to housing and related facilities owned and used by qualified organizations. The standard is whether the use of the property by the organization for housing and related facilities is a use that is incidental to and reasonably necessary for the accomplishment of the exempt purposes of the organization. For purposes of applying the uniform statewide standard, the phrase “Use of property that is incidental to and reasonably necessary for the accomplishment of the exempt purposes of the organization” includes the use of property that is institutionally necessary for the operation of the organization as provided in subdivision (i) of section 214 of the Revenue and Taxation Code.
For purposes of determining eligibility for the welfare exemption, it is the use of the parsonage and related facilities by the organization owning the property that is to be considered, not the occupants use. If the organization’s use of the parsonage is incidental to and reasonably necessary for the accomplishment of the organization’s exempt purposes, the property is eligible for exemption. The occupant’s use for residential purposes is secondary to the organization’s primary exempt purpose and shall not disqualify the parsonage from exemption either in whole or in part.
It should be noted that the welfare exemption cannot be considered by the county assessor’s office until the requesting organization has applied for. This requires the granting of an Organizational Certificate of Clearance by the State Board of Equalization. This process is much more involved than obtaining a Church or Religious exemption. It requires accounting documents, and review of the organizations Articles of Incorporation as to their meeting current law. Thus, it can be lengthy to prepare and process,
Parsonage Income and Unrelated Business Income Tax:
Another consideration is whether or not the church is liable for Federal Income tax. The same scenario above comes into question if the income is received from a church employee, and is the rental of the parsonage incidental to and reasonably necessary for the religious purpose of the church.
According to the Internal Revenue Service, “If an exempt organization regularly carries on a trade or business not substantially related to its exempt purpose, except that it provides funds to carry out that purpose, the organization is subject to tax on its income from that unrelated trade or business.” However, in the case of income received from the rental of a church parsonage, providing the parsonage is not debt financed, such income is “excluded in computing unrelated business taxable income.”
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Disclaimer: Every situation is different and particular facts may vary thereby changing or altering a possible course of action or conclusion. The information contained herein is intended to be general in nature as laws vary between federal, state, counties, and municipalities and therefore may not apply to any given matter. This information is not intended to be legal advice or relied upon as a legal opinion, course of action, accounting, tax or other professional service. You should consult the proper legal or professional advisor knowledgeable in the area that pertains to your particular situation.