Gnomes live in mushrooms that grow in our backyard.
Kims grandmother told her this when she spotted some mushrooms that had grown in their grass when she was young. Every time Kim would spot some mushrooms in the grass she would tell her grandmother and her grandmother would tell her a new fact about gnomes and their lives in the little mushrooms.
Kims grandmother is of African-American and white descent. Kim believes that her grandmother learned this story from her white side of the family since gnomes are an European folkloric creature. In this situation, the story was simply used to awe and entertain a young child. Even though her grandmother did not actually believe that gnomes lived in mushrooms she saw it as an interesting and imaginative story to share with her granddaughter.