The Foreign Housing Exclusion: A Brief Guide for US Expats
The Foreign Housing Exclusion allows American expats to deduct reasonable housing expenses from their taxable earned income.
The Foreign Housing Exclusion is granted in conjunction with the Foreign Earned Income Exclusion, but neither are granted automatically: you have to apply for them and file form 2555 with your annual return.
The Foreign Housing Exclusion is typically a good option for people who live in rented property while living and working abroad and who earn more than the Foreign Earned Income Exclusion limit ($108,700 in 2021).
All US citizens and green card holders are required to file a US federal tax return reporting their worldwide income, wherever in the world they live. The Foreign Earned Income Exclusion and the Foreign Housing Exclusion offer ways for r US expats to avoid double taxation on their earned income.
How to claim the Foreign Housing Exclusion
To claim the Foreign Housing Exclusion, you have to first claim the Foreign Earned Income Exclusion. To claim the Foreign Earned Income Exclusion, you have to file IRS Form 2555 when you file your US tax return. Form 2555 requires that you demonstrate that you live abroad using either the Physical Presence Test, showing that you spent more than 330 days outside the US in the tax year, or the Bona Fide Residence Test, proving that you are legally resident in another country.
The Foreign Earned Income Exclusion lets qualifying expats exclude up to around $110,000 of their earned income from US income tax. The exact figure rises a little each year for inflation. Note that passive income such as rental income, retirement income, or income from investments can’t be excluded using the Foreign Earned Income Exclusion. Expats who earn more than the annual threshold and who rent their home abroad can also claim the Foreign Housing Exclusion.
The Foreign Housing Exclusion lets expats further exclude an amount related to some of their housing expenses, including:
- Rent, or the fair rental value of housing provided by your employer
- Utilities (except for telephone charges and pay TV services)
- Necessary repairs
- Property insurance (including contents)
- Fees for securing a leasehold
- Occupancy taxes
- Residential parking
- Rental of furniture and accessories
Domestic help, mortgage payments, and purchased furniture on the other hand cannot be claimed.
“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.” – the IRS
Furthermore, the claimable expenses in total cannot exceed your foreign earned income, but must exceed what the IRS calls the ‘base amount’ for the place you live. For most places, the base amount is 16% of the amount of Foreign Earned Income Exclusion claimed (so a maximum of 16% of $108,700 in 2021, or $17,392).
How to calculate how much income can be excluded using the Foreign Housing Exclusion
The IRS uses a complex formula to calculate how much earned income above the Foreign Earned Income Exclusion threshold can be excluded from income tax using the Foreign Housing Exclusion on Form 2555. The calculation is as follows:
First, calculate the total of your qualifying housing expenses, and check that this figure exceeds the ‘base’ amount.
Now deduct the base amount from your qualifying housing expenses. The figure that you are left with is called the ‘housing amount’.
Now check that the housing amount doesn’t exceed the maximum housing expenses limit for where you live. This is normaly 30% of the Foreign Earned Income Exclusion limit, however the IRS recognizes that some places have higher housing costs, so they publish a list of limits for these places. You can see the full list on the Form 2555 guidance notes, on page six.
Now add the housing amount on to the Foreign Earned Income Exclusion limit to get the full figure that you can exclude from income tax.
Can self-employed expats claim the Foreign Housing Exclusion?
If you’re self-employed, you cannot claim teh Foreign Housing Exclusion. However, you can claim the Foreign Housing Deduction by deducting your housing expenses from your gross income to reduce your tax liability. Neither the Foreign Earned Income Exclusion nor the Foreign Housing Deduction reduce your self-employment tax liability though.
When should expats claim the Foreign Housing Exclusion?
Expats who pay foreign income taxes at a higher rate than US income tax rates most often benefit more from claiming the Foreign Tax Credit than the Foreign Earned Income Exclusion and the Foreign Housing Credit. This is because the Foreign Tax Credit, which is claimed on Form 1116, provides the same value of US tax credits as the value of foreign income taxes paid, so eliminating US tax liability completely. So generally speaking the Foreign Housing Exclusion is useful for expats who don’t pay more foreign income tax than the US income tax they’d owe, who earn over the Foreign Earned Income Exclusion limit, and who rent their home abroad.
Filing US taxes from abroad is complex, and the most beneficial way to file differs depending on each individuals circumstances – their income types and levels, and where they live, for example. 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.