Many California churches have a parsonage sitting empty or rented out to non-members. While renting the parsonage generates income, it also creates significant tax risks that most churches don’t anticipate. The two primary concerns are losing your property tax exemption and triggering federal unrelated business income tax (UBIT). This guide explains when renting your parsonage puts your church’s tax-exempt status at risk, and how to protect your exemptions.
Church 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 church parsonage may still qualify under a welfare exemption, provided its use can be deemed incidental to the church’s purpose for which it was established — religious worship. It does not need to be adjacent to or on the church site.
As far as the California State 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 partial exemption for property taxes. However, the situation in which the church parsonage is being rented will come into play. Relevant factors include, but are not limited to, who lives there, for how long, and how much rent is received.
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 a religious purpose, is reasonably necessary for religious worship.
Institutionally Necessary: What the Law Requires
With respect to employee housing provided by qualified organizations, the Legislature enacted Revenue and Taxation Code 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, including a church parsonage, will be exempt if it is institutionally necessary for the operation of the organization.
Church Parsonage Welfare Exemption
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, and to establish a single uniform statewide standard for determining qualification for the welfare exemption as it applies to such properties.
Rule 137 provides that housing and related facilities owned and used by organizations 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. The standard is whether the organization’s use of the property for housing is incidental to and reasonably necessary for the accomplishment of its exempt purposes. For a full statement of the rule, see the California State Board of Equalization’s Rule 137.
For purposes of determining eligibility for the welfare exemption, it is the use of the church parsonage and related facilities by the organization owning the property that is considered, not the occupant’s use. If the organization’s use of the parsonage is incidental to and reasonably necessary for the accomplishment of its exempt purposes, the property is eligible for exemption. The occupant’s residential use is secondary to the organization’s primary exempt purpose and does not, by itself, disqualify the parsonage from exemption, in whole or in part.
The welfare exemption cannot be considered by the county assessor’s office until the requesting organization has applied for and been granted an Organizational Clearance Certificate by the State Board of Equalization. This process is more involved than obtaining a Church or Religious exemption. It requires accounting documents and a review of the organization’s Articles of Incorporation to confirm they meet current law, so it can take time to prepare and process.
Church Parsonage Rental Income and Unrelated Business Income Tax
A separate consideration is whether the church is liable for federal income tax on parsonage rental income. The same question arises here: is the rental of the church 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 the income from that unrelated trade or business. However, in the case of income received from the rental of a church parsonage, provided the parsonage is not debt-financed, that income is excluded in computing unrelated business taxable income under Revenue and Taxation Code section 214.
Related articles
Churches And Property Tax Exemptions
Churches And Unrelated Business Income Tax
How Zoning Codes Effect Churches
First Right of Refusal
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.
