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Moving overseas to live and work in a new country can be stressful. It’s not easy to sell your things, say goodbye to loved ones, and adapt to a new culture.
Additionally, the potentially high costs of moving overseas prohibit many Americans from taking the leap. Since the US has a citizenship-based taxation system, you’ll still have to file your US taxes, even once living in your new home country.
Thankfully, living overseas doesn’t have to be as expensive as you think. One of the many tax provisions the IRS provides to expats is a Foreign Housing Exclusion provision to help international taxpayers save money on their US tax return.
In this article, we’ll explain the Foreign Housing Exclusion and answer the most common questions we receive from our clients about this tax benefit.
What is the Foreign Housing Exclusion?
The Foreign Housing Exclusion (FHE) allows American taxpayers living abroad to exclude income they earn abroad from their taxable income on their US returns. The exclusion is based on the amount of their foreign housing expenses.
The FHE is a good option for US expats living abroad who make more than the Foreign Earned Income Exclusion (FEIE) limit ($120,000 for the 2023 tax calendar year and $126,500 for 2024). Along with the Foreign Earned Income Exclusion, the FHE may help expats avoid double taxation and reduce their owe to the IRS.
You file your FHE claim you’ll use the same tax form as the FEIE, Form 2555.
Note:
The FHE is sometimes called Foreign Housing Deduction (FHD). While the terms “exclusion” and “deduction” often overlap in casual use, they have specific meanings in tax terminology, especially in how they affect taxable income and tax liability for self-employed individuals.
What are the qualifications for using the Foreign Housing Exclusion?
The FHE isn’t an option for all US expats. To qualify for the FHE, you must go through the same eligibility requirements as the FEIE, which include:
Bona Fide Residence Test
The Bona Fide Residence Test involves proving social and economic ties with your new host country. It’s a good option for US expats who have already established residency in another country and have no plans to leave.
To qualify for the Bona Fide Residence Test, you need to be a resident of a country for an entire calendar year (with no interruptions). Documents to help you qualify as a Bona Fide resident include a rental contract or a permanent residency visa in a foreign country.
Physical Presence Test
The Physical Presence Test involves being physically present in a foreign country for at least 330 days during any 365 day consecutive period.
Unlike Bona Fide Residence, you don’t need residency in another country to pass the Physical Presence Test, as long as your tax home is outside the US. Whether or not you plan to return to the US also doesn’t matter.
Can self-employed expats benefit from the Foreign Housing Exclusion?
Self-employed expats can claim the FHE.
However, when self-employed expats claim this provision, it’s considered a deduction rather than an exclusion. This is because it deducts their housing expenses from their gross income to reduce their tax liability.
The deduction, however, will not reduce self-employment tax liability. That includes the 12.4% Social Security tax and the 2.9% Medicare tax.
Self-employed expats who earn under around $100,000 won’t need to claim the Foreign Housing Deduction, as they will already have excluded all their income from US tax liability.
Self-employed expats who earn over $100,000, though, will benefit from removing more of their income from US tax liability. Those who rent accommodation abroad and are claiming the Foreign Earned Income Exclusion can do this by claiming the Foreign Housing Deduction.
The Foreign Housing Deduction allows self-employed expats to deduct their allowable rental housing expenses, minus what is called the base housing amount, which is calculated as 16% of the Foreign Earned Income Exclusion limit (so around $16,000, though the figure rises each year in line with the Foreign Earned Income Exclusion limit), from their taxable income.
There is an upper limit on the amount of rental housing expenses that can be claimed, and this limit depends on where you live.
(The IRS publishes a list of these amounts – see p6).
Note:
To calculate how much of their income self-employed expats can deduct by claiming the Foreign Housing Deduction, they should calculate their total housing expenses (which must exceed the base housing amount), check that this total doesn’t exceed the upper limit the IRS has set for where they live, and lastly, deduct the base housing amount.
Two points worth noting are that even self-employed expats who can exclude their entire income from US tax are still liable to file a US tax return and calculate self-employment (social security and Medicare) taxes.
Secondly, self-employed expats who pay more foreign taxes than they would owe to the IRS may be better off claiming the Foreign Tax Credit instead of the Foreign Earned Income Exclusion and the Foreign Housing Deduction.
Expenses that qualify for the Foreign Housing Exclusion (FHE)
A wide range of housing expenses are eligible for exclusion or deduction. Qualified housing expenses that the Foreign Housing Exclusion or Deduction can cover include:
- Rent, or the fair rental value of housing provided by your employer
- Utilities (except for telephone charges and TV services)
- Necessary repairs
- Property insurance (including contents)
- Fees for securing a leasehold
- Occupancy taxes
- Residential parking
- Rental of furniture and accessories
The FHE cannot cover any foreign housing expenses considered fancy or lavish. According to the IRS:
“Housing expenses do not include expenses that are lavish or extravagant under the circumstances, the cost of buying property, purchased furniture or accessories, and improvements and other expenses that increase the value or appreciably prolong the life of your property.”
Other expenses that don’t qualify for the FHE include:
- Domestic labor (such as hiring someone to cook or clean)
- Mortgage payments
- Purchased furniture
- Home improvement projects
What is the maximum exclusion amount under the Foreign Housing Exclusion?
The maximum expense that you can exclude will depend on the total amount of your housing expenses and the base housing that the IRS permits you based on your location. Your eligible expenses also can’t exceed your foreign-earned income.
The IRS offers US expats a base housing of 30% of FEIE. However, because different cities have different living costs, the maximum amount will depend significantly on where you’re currently living.
How to calculate the Foreign Housing Exclusion
As mentioned earlier, you’ll calculate your FHE with Form 2555. Here’s how you can calculate the excludable income under FHE:
- Calculate your total housing expenses in your host foreign country across an entire tax year.
- Calculate your FEIE for your US tax return.
- Deduct the base amount from your qualifying housing expense to determine your “housing amount”.
- Make sure your housing expenses don’t exceed the maximum housing expense limit based on where you live. You can find the IRS list of cities and housing expense limits on page 6 of Form 2555 instructions.
- Add the housing amount to the Foreign Earned Income Exclusion limit to get the total figure you can exclude from income tax.
You will include the amount of your FHE as part of your FEIE on your US tax return.
If you’re a self-employed US expat, the process will look different. In your case, you’ll file a claim for Foreign Housing Deduction in Part IX of Form 2555.
Remember:
One important mention is that if an expat couple lives together, only one partner can file a claim for their FHE. Married expat couples should calculate their housing expenses together. Some expat spouses may not live in the same house in some situations. In this case, each partner can file their FHE or deduction claim separately based on their tax return. Each partner's home must not be within a short commuting distance of each other to qualify for this option.
Claim your Foreign Housing Exclusion with the right team of experts
Moving overseas doesn’t have to be excessively expensive. In fact, with the proper tax preparation and understanding of the credits and exclusions available to you, it can even create tax-savings.
The most beneficial way to file depends on an individual’s circumstances, including income types and amounts, where they live, and other factors. If you have any questions about your situation, always seek advice from an expat tax specialist.
If you’re behind with your US tax filing from abroad because you weren’t aware of the requirement to file, you may be able to catch up without facing penalties under the Streamlined Procedure program.
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