US Expat Taxes Explained: The Foreign Housing Expense

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This week, we are introducing a new series to help Americans living abroad  better understand the laws applied to an individual’s overseas tax return. We know that an overseas tax return can feel a bit daunting sometimes. So, this series aims to bring a bit more clarity to some areas of US expat taxes that may affect you, but you may not yet understand. Have a topic you want us to cover? No problem! Email us at info(at)greenbacktaxservices.com.

The Foreign Housing Expense on Your Overseas Tax Return

As you may know, as an American living overseas you may be able to deduct some of your housing expenses from your gross income on your overseas tax return. This is known as the Foreign Housing Allowance. Basically, this is the IRS’s way of saying, “Yes, we understand that the cost of housing outside the US is not the same as the cost of housing inside the US.”

As a result, you may need to spend more on housing, which could negatively impact you financially. So, the IRS offers a deduction for a part of your foreign housing expense based on where you live and how many days you live outside the US. In order to qualify, you will need to meet the Bona Fide Residence Test or the Physical Presence Test. However, in short, in order to qualify, you will need to either be living and working abroad full-time, or you will need to reside outside of the US for 330 days in a 365-day period.

How does this work? How much of my housing expense can I deduct on my overseas tax return?

The amount of money your are allowed to deduct is based on the Foreign Earned Income Exclusion limits. For the 2010 tax year, the FEIE is $91,500 and you can deduct up to 30% of this as part of your Foreign Housing Deduction. So, you take $91,500 x .30 = $27,450. You are allowed to deduct a maximum of $27,450 per year for your housing expenses.  Examples of qualifying housing expenses include rent, repairs, utilities (excluding telephone bills), personal property insurance, leasing fees, furniture rental and parking.  Expenses that do not qualify include “lavish or extravagant” expenses, mortgage payments, the cost of domestic labor, television subscriptions and purchased furniture.  If you are unsure as to which of your expenses qualify, we suggest you contact your US expat tax preparer.

However, you should also know that the IRS adjusts the maximum limitation based on geographic differences in housing costs, relative to the cost of housing in the US. The IRS publishes a table of more than 400 foreign locations which qualify for a higher deduction limit on an overseas tax return. For example, if you live in London your housing allowance would be $83,400; in Paris your maximum allowance would be $84,800; in Singapore it would be $67,000; in Hong Kong it would be $114,300; in Perth you would be able to deduct up to $32,782; and in Dubai you could deduct up to $57,174.

How can I calculate how much I can deduct?

The first thing you need to do is calculate your base amount. Your base amount is the minimum amount of your housing that you will need to pay for, and you will not be able to deduct (think of this as the amount you would have needed to pay if you lived in the US). Currently, this is calculated as 16% of the maximum Foreign Earned Income Exclusion. For 2010, it would be $91,500 x .16 = $14,640, or $40.11 per day. Now, let’s say you live in London, where your qualified housing costs equaled $83,400, or $238.29 per day, and you were outside the US for 350 days in 2010. Then, your maximum deduction would equal ($238.29 – 40.11) x 350 = $69,363. This is an additional $41,493 above the standard deduction amount — not too shabby.

The foreign housing expenses can be a significant money saving tool on an overseas tax return.  If you have questions about your overseas tax return and the foreign housing expenses, feel free to contact our expat CPAs.