The Foreign Housing Exclusion: What Expats Need to Know
The Foreign Housing Exclusion allows American expats to deduct reasonable housing expenses from their taxable foreign earned income.
The 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 earning a little more than the Foreign Earned Income Exclusion limit ($100,800 in 2015).
All US citizens and green card holders are required to file a tax return and pay tax on their worldwide income, wherever in the world they live. The Foreign Earned Income Exclusion and the Foreign Housing Exclusion offer ways to avoid double taxation on foreign earned income, paying to the IRS as well as in the country where the income is earned.
The small print
To claim the Foreign Housing Exclusion, you have to claim the Foreign Earned Income Exclusion. To claim the Foreign Earned Income Exclusion, you have to prove 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 IRS is very specific about which housing expenses can be claimed under for the Foreign Housing Exclusion:
- 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.
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 $100,800 in 2015, or $16,128).
How to calculate how much income can be excluded
“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
Never a stickler for simplicity, the IRS has come up with the following formula to calculate how much foreign earned income can be excluded from income tax under the Foreign Housing Exclusion.
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 here, 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.
If you’re self employed, you are eligible to claim the Foreign Housing Deduction rather than Exclusion, while if you and your spouse file separate returns, only one of you can claim the Exclusion (or Deduction).