Housing Question

[bisimpson]

I have the opportunity to claim a housing allowance through my job. The way that I understand the tax code I can declare the value of rent as housing. My job will deduct that from my salary and pay me a housing allowance—what I declare. Obviously, the more I declare, the lower my income and the lower my taxes. So two questions:

1. My mortgage payment is $1400, but the rents in our area are about $2200—this is from about two minutes on Zillow, is there some other place I ought to check? Is it possible to declare the $2200 and then put the difference toward the principle of the loan? Are there any other issues? I’ve rolled our utilities and improvements into our housing number as well.

2. Is this a good idea? How would this fit into the investment order? Obviousy, once if we pay off our house, our housing number will drop. Pros? Cons?

[terran]

I have a hard time believing just anyone can receive a tax advantaged housing allowance (and my brief research seems to confirm this). Are you clergy or a member of the military?

[bisimpson]

Clergy. I have claimed this in the past, but I'm not sure how to take advantage of it.

This is really all that I can find on it:

https://www.irs.gov/faqs/interest-dividends-other-types-of-income/ministers-compensation-housing-allowance/ministers-compensation-housing-allowance

[terran]

It's basically the same as what your link says, but from https://www.irs.gov/publications/p517#en_US_2017_publink100033610

Home ownership.
If you own your home and you receive as part of your salary a housing or rental allowance, you may exclude from gross income the smallest of:

• The amount actually used to provide a home;
• The amount officially designated as a rental allowance; or
• The fair rental value of the home, including furnishings, utilities, garage, etc.

Excess rental allowance.
You must include in gross income the amount of any rental allowance that is more than the smallest of:

• Your reasonable salary,
• The fair rental value of the home plus utilities, or
• The amount actually used to provide a home.

If your congregation is willing to set your housing allowance amount at whatever you ask them to, then it would seem that your limit will be either the actual amount of your mortgage and utilities or the fair market rent of your house. Since it says "the amount actually used to provide a home" I wouldn't think you can just put extra towards principle, but I would think you could refinance to either take some equity out or to a shorter term, thereby increasing the amount. Whether this makes sense would probably depend on your marginal tax rate (what you'll save) and the costs associated with refinancing.

Another concern I would have is that it looks like while the the housing allowance is not taxable income, it is subject to self employment tax. Is your other income also subject to self employment tax, or does your congregation pay the employer portion of FICA? If you're already paying self employment tax on your regular income then shifting income to the housing allowance won't change that, but if this will shift more of your income to being subject to self employment tax then that's something to consider.

[bisimpson]

@terran This is extremely helpful. Just reading the link content from your quote, for the first time I see: "the smallest of." I never noticed that before.

On your second concern—that's how I understand it. The allowance is not taxable income, so the idea is that if I can up the claim, it would lower my tax basis. Of course, I have to use it on housing. Right now we're paying quarterly.

Generally, I think we make good financial decisions. We spend less than we make, we invest. But working through these forums really makes me want to up our game and come up with a good gameplan.

Thanks again.

[terran]

On your second concern—that's how I understand it. The allowance is not taxable income, so the idea is that if I can up the claim, it would lower my tax basis. Of course, I have to use it on housing. Right now we're paying quarterly.

My second concern is actually that my understanding is that the housing allowance is subject to self employment tax. If you regular income is subject to self employment tax (is it?) then it doesn't matter because you'll pay it either way, but if not then that a 7.65% (the employer half of self employment tax) that you'll need to overcome with your regular income tax savings to make it make sense (in addition to any refinancing costs).

[bisimpson]

I'm not sure. I believe we are paying self employment tax, but I assumed it did not include our HA. It looks like the IRS says that it is. It looks like I need to do some homework on this.

Generally, we have tried to pay off our mortgage as quickly as possible without paying attention to the HA. But I felt like this is something we need to take advantage of.

[NathanP]

Just throwing this out there.. Consider refinancing to a shorter term mortgage if the size of your mortgage payment is the smallest dollar amount in the IRS list.

[Nords]

Just throwing this out there.. Consider refinancing to a shorter term mortgage if the size of your mortgage payment is the smallest dollar amount in the IRS list.

I've fallen into that trap before.  Be very careful about your long-term planning before locking yourself into a short-term mortgage.

When my dual-military spouse and I were stationed in Hawaii, we bought a house.  ("Because real estate always goes up.")  Back in 1989 our military housing allowance was a two-part system ("basic" plus "variable"), and you had to document a bigger mortgage (or a higher rent) to get the variable part of the allowance. 

We started off at a 30-year fixed-rate mortgage P&I payment of $1841/month, which handily qualified us for both parts of the allowance.  Over the next couple years we both promoted to a higher rank-- and became eligible for a bigger housing allowance.  Now we were in danger of losing the variable part of our eligibility for the housing allowance.  We knew that we wanted to stay in Hawaii, so we had a long-term perspective and we decided to refinance.  Our credit union happily moved us into a 10-year mortgage, which coincidentally was exactly the size of our new bigger (basic + variable) housing allowance:  $2632/month.  Life was good.

I remember those numbers very clearly because of subsequent events.

You military veterans know what happened next:  the 1993 Base Realignment And Closure legislation.  A bunch of personnel changes were inflicted on my spouse's community, a bunch of billets were moved around, and suddenly she couldn't get a follow-on tour in Hawaii.  We ended up taking orders to San Diego, expecting to come back to Hawaii in a few years.

The financial impact was that we spend 39 months with a $2632/month mortgage P&I payment, while only receiving $1900/month in rent.  (And we had far more landlording expenses than just the P&I payment.)  Meanwhile in San Diego our housing allowance was $2000/month, but we were spending $1600/month on our own rent payments. 

We eventually returned to Hawaii-- and to that house.  $13K over three years didn't break our bank, but it was certainly painful to look at.

We still own that house today.  And real estate eventually did go up... at almost precisely the long-term rate of inflation. 

We would've been in much better shape if we'd rented in Hawaii, or at the very minimum thought through the possibility that we wouldn't be able to stay there for follow-on tours.

[bisimpson]

@NathanP This is exactly what we are considering. I need to do some work on the cost of the refi—how much will the HA save us?  Is it really worth it? Would the money we save on taxes just go to the bank? And will I be more efficient getting the money in the market?

@Nords Fascinating story. Thank you for sharing it. That's one of our concerns with the refi. It would work great as long as we get a HA. If there's a change in the tax code or lose my job, we're stuck with a pretty hefty payment. We've been in the DC area for two years—we're getting pretty familiar with how frequently you all in the military move around—we just made some friends who will be restationed to Hawaii this month. Thanks to you and your wife for your service.

[Nords]

@Nords Fascinating story. Thank you for sharing it. That's one of our concerns with the refi. It would work great as long as we get a HA. If there's a change in the tax code or lose my job, we're stuck with a pretty hefty payment. We've been in the DC area for two years—we're getting pretty familiar with how frequently you all in the military move around—we just made some friends who will be restationed to Hawaii this month. Thanks to you and your wife for your service.

Thanks for your support, and I'm glad our experience can help someone else avoid this problem! 

And yes, we move too often in the military.  That makes home-buying particularly risky.