Many expats know about the Foreign Earned Income Exclusion, which helps to lower your gross income and therefore lower your US tax liability, but did you know that there is a way to lower your income even further by using the Foreign Housing Exclusion? Check out everything you need to know about the lesser-known exclusion now.
What is the Foreign Housing Exclusion?
The Foreign Housing Exclusion is available to US expats (which includes US citizens and resident aliens) to reduce taxable foreign earned income. This exclusion can only be used in addition to the Foreign Earned Income Exclusion – meaning you must qualify for the FEIE first. The Foreign Earned Income Exclusion is available to Americans living abroad with foreign earned income if they meet the requirements for the bona fide residence test or the physical presence test.
The bona fide residence test stipulates that you must be a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year. The physical presence test specifies that you have physically been in a foreign country or countries for 330 or more full days during a 12-month period. Meeting requirements for one of these tests is how you use the Foreign Earned Income Exclusion.
Foreign Housing Exclusion Example: Who Can Take It?
If you meet the requirements of the Foreign Earned Income Exclusion, you may be able to take the Foreign Housing Deduction. As a Foreign Housing Exclusion example, it’s dependent on both the amount of your expenses and what country you live in. If you don’t qualify for the FEIE, you will not be able to take the Foreign Housing Deduction as this is one of the main requirements.
What Are the Requirements and Qualified Housing Expenses?
In order to claim the Foreign Housing Exclusion, you must meet the following conditions:
- You must qualify for, and claim, the Foreign Earned Income Exclusion – The FEIE is a reduction in your foreign earned income, lowering your taxable income on your US tax return. This exclusion requires you to either be outside the US for 330 days within a 365 day window, or be a “bona fide” resident of a foreign country. If you qualify for the FEIE, you must also claim the benefit on your tax return in order to claim the added housing exclusion. If you choose not to claim the FEIE on your tax return, you cannot claim the Foreign Housing Exclusion.
- You must have qualified housing expenses – Qualified foreign housing expenses include the following: rent, utilities (except for telephone, TV services, and internet), personal property insurance (such as homeowner’s or renter’s insurance), leasing fees, furniture rental, parking rental, and repairs. You cannot use mortgage payments, domestic labor (maids, housekeepers, etc.), purchased furniture, and anything deemed “lavish or extravagant.” Additionally, your foreign housing deduction cannot exceed your total foreign earned income for the tax year.
- You must have paid your housing expenses from employer provided funds – Employer provided funds are any amounts paid to you by your employer and are included in your gross income for the year. The amounts can either be designated as housing funds, or part of your regular salary. If your employer pays your housing expenses, and you do not include that amount in your gross income (the amount you use to calculate the FEIE), then you cannot use the housing expenses to calculate the deduction.
- Example #1 – You earn a regular salary from your employer, none of which is specified for your housing. You can use the amounts paid for your qualified housing expenses to calculate out the Foreign Housing Exclusion
- Example #2 – You earn a regular salary from your employer plus an additional $2000/month for housing expenses. You only spend $1000/month on qualified housing expenses, and save the rest. You will be able to use the $1000/month you spent on housing to calculate the Foreign Housing Exclusion, but will have to include the entire $2000 salary addition in your gross income to calculate the Foreign Earned Income Exclusion.
- Example #3 – You and your family live in an apartment paid for directly by your employer. The apartment’s rent is $2000 per month. Your yearly salary is $100,000. You are required to include the $24,000 of rent paid in your income for the year, bringing your salary to $124,000. You would be able to use the $24,000 of rent to calculate the Foreign Housing Exclusion.
- Your housing expenses must exceed the base amount specific for your location – Once your expenses have surpassed a base amount, determined by the IRS, you can take the housing exclusion up to the maximum allowed by your location. Currently the base amount is 16% of the FEIE, and the maximum amount is based upon your location (or the location of where the expenses were incurred). Check out our infographic outlining the cities with higher exclusions here and all the IRS exclusions listed here.
How is the Foreign Housing Exclusion Calculated?
The Foreign Housing Exclusion is calculated on Form 2555, along with the Foreign Earned Income Exclusion.
Once you have determined that you qualify to take the Foreign Housing Exclusion, you will then have to figure out how much of your housing expenses you will be able to take on your tax return.
- First, calculate your total qualified foreign housing expenses for the calendar year
- Next figure out how much Foreign Earned Income Exclusion you will take on your tax return
- Multiply the FEIE by 16%. This is your base amount that you must exceed in order to claim the Foreign Housing Exclusion.
- The amount of your qualified foreign housing expenses over the base amount are then compared to the limits set for your location. Here is a location limit list (starting of page 6). You can take the larger of your expenses (in excess of the base amount) or the location limit.
- The amount of Foreign Housing Exclusion allowed is added to your Foreign Earned Income Exclusion amount, and the total is entered on your tax return, Form 1040.
Anything Else Expats Need to Know?
- If you are self-employed, you will need to calculate the housing expenses in a different way. Your housing expenses are considered a deduction instead of an exclusion. While the amount is still figured on Form 2555, it does not get added to your Foreign Earned Income Exclusion on the Form 1040, instead it gets entered on line 36 in the adjustments section. You cannot use the foreign housing expenses you use to figure a home office deduction to calculate the foreign housing expense deduction.
- Example: You have a home based business doing consulting work for a magazine. Your total qualified housing expenses for the year are $10,000. On your schedule C, you take a $3000 deduction for your home office. When figuring your Foreign Housing Deduction (in conjunction with your Foreign Earned Income Exclusion), only $7000 of the expenses will be available to use, as you have already deducted $3000 on your return.
- The Foreign Housing Deduction will reduce your total taxable income, and therefore your income tax, but will not reduce any self-employment tax you owe from your self-employment income.
- Married couples living together must calculate their housing expenses jointly. If they file a joint tax return, either spouse (but not both) can claim the Foreign Housing Deduction on their Form 2555. If the married couple files separate returns, only one can claim the Foreign Housing Exclusion. Married couples living in separate households can claim separate housing exclusions if their homes were not within reasonable commuting distances from each other’s residence or tax home (where you primarily live and work).
- If you moved during the year, and have expenses from more than one foreign location, you will need to split the expenses based upon the location. The amount of your location limitation will be calculated based upon the total number of days spent at each location during the year.
Need help calculating your Foreign Housing Deduction
Simply contact our expert accountants who can explain what living expenses you can deduct with this Foreign Housing deduction!