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 learn to adapt yourself to a new culture.
Additionally, an aspect of moving overseas that prohibits many Americans from taking the leap is the potentially high costs of such a move. On top of that, since the US has a citizenship-based taxation system, you’ll still have to file your US taxes even 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 returns.
In this article, we’ll dive into what the Foreign Housing Exclusion is all about and answer the most common questions we get from our clients about this tax deduction.
What is the Foreign Housing Exclusion?
The Foreign Housing Exclusion (FHE)1 allows American expats living abroad to exclude income they earn abroad from their taxable income on their US returns. The exclusion is based on a significant portion 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 limit ($112,000 for the 2022 tax calendar year). Along with Foreign Earned Income Exclusion (FEIE), the FHE helps expats avoid double taxation and reduce what they owe to the IRS.
You file your FHE claim on the same tax form as the FEIE, Form 2555.2
You must file this form with your tax return before the IRS filing deadline for those who reside abroad, June 15, 2023 (unless you file an extension!).
What are the qualifications for Foreign Housing Exclusion?
The FHE isn’t an option open to 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 Test3 involves proving the social and economic ties with your new host country. The test is a good option for US expats who have already established residency in another country with no plans of leaving.
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 Test4 involves being physically present in a foreign country for at least 330 days during any 12-month consecutive period. Unlike Bona Fide Residence, you don’t need residency in another country to pass the Physical Presence Test. 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, as opposed to an exclusion. The reason for this is that it deducts their housing expenses from their gross income to reduce tax liability.
The deduction, however, will not reduce self-employment tax liability. That includes the social security tax of 12.4% and Medicare tax of 2.9%.
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.”5
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 amount of 30% of FEIE.6 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 that’s going to be in your US tax return.
- Deduct the base amount from your qualifying housing expense to determine your “housing amount”.
- Make sure that your housing expenses don’t exceed the maximum housing expenses of where you live. You can find the IRS’ list of cities and their housing expenses limits on page 6 of Form 2555 instructions.
- Add the housing amount to the Foreign Earned Income Exclusion limit to get the whole 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 be different. In your case, you’ll file a claim for Foreign Housing Deduction in Part IX of Form 2555.
One important thing to mention is that if an expat couple lives together, then only one partner can file a claim for their FHE. Married expat couples also have to calculate their housing expenses together.
Some expat spouses may not live in the same house in some situations. In this case, each partner has to 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 be tax-saving.