Brighton & Hove Council told the home to ask pensioners four times a year about their sexual orientation under its 'fair access and diversity' policies, which stem from New Labour equality laws.
Council chiefs also accused the charity that runs the home of 'institutional discrimination', before cutting a £13,000 grant towards warden services.
Pilgrim Homes, which operates ten schemes for elderly Christians across the UK, says it has never breached the law and is now suing the council, accusing it of religious discrimination.
Andrew Jessop, the charity's chief executive, said: 'The council has taken overzealousness to the extreme. People in their 90s are very vulnerable and shouldn't be treated in this way.'
Tensions began last year when the council imposed stricter criteria on organisations it supported to 'comply' with the Equality Act 2006 and the Equality Act (Sexual Orientation) Regulations 2007.
It circulated a questionnaire to the Pilgrim Home in Egremont Place, Brighton, which houses 39 single Christians aged over 80, including former missionaries and a minister.
Phil Wainwright, director of human resources for Pilgrim Homes, said he was told by the council the home had to ask residents if they were lesbian, gay, bisexual, heterosexual or 'unsure', even if they objected. Many of the elderly rebelled, however, and the home wrote to the council saying residents did not want to participate.
Mr Wainwright said: 'There was a strong feeling among people in the home that the questions were inappropriate and intrusive. They felt they had come to Pilgrim Homes because of its Christian ethos and were upset they were not protected from such intrusions.'
But Brighton & Hove Council complained about the home's 'negative response' and argued that because the home had a Christian ethos, homosexual people might be deterred from applying.
It cited the 'resistance' to using images of elderly gays, lesbians, bisexuals and transgender people in the home's leaflets, saying this meant gays and lesbians 'would not feel comfortable' applying for a place.
The council then announced it was axeing the grant because there had been 'limited progress' in making the home accessible to the homosexual community.
Mr Wainwright said the charity was open to anyone with orthodox beliefs.
He said: 'We have every reason to believe that we have given places to gay Christians, and no questions were ever asked. The council hasn't demonstrated any discrimination on our part. We believe it is Brighton Council that is institutionally discriminatory.'
MPs backed the charity, which fears other councils that provide it with grants totalling more than £100,000, could follow Brighton's lead.
Ann Widdecombe, former Tory Home Office Minister, said: 'The equality law does not oblige anyone to ask intrusive questions. This sort of thing needs to be nipped in the bud.'
David Davies, Tory MP for Monmouth, said: 'It is absolutely disgraceful that the council has tried to get 90-year-olds, from a generation that wasn't obsessed with sex, to put intimate information on to one of its forms.'
But Brighton & Hove Council said: 'We have never expected any residents to answer questions about their sexuality if they preferred not to do so.
'The Government specifically states the home must be open to the gay and lesbian community and that it must demonstrate this to qualify for funding. In the absence of any willingness to do this, funding has been withdrawn.' [Mail]