Today, we are going to discuss the foreign housing exclusion, also referred to in form 2555, parts 6, 8 and 9. The foreign housing exclusion is a great way a U.S. expat can reduce their U.S. tax burden. However, the rules are cumbersome and confusing so make sure you pay attention while I walk you through the form.
What is the Foreign Housing Exclusion?
The Foreign Housing Exclusion is a reduction in your income that works in conjunction with the Foreign Earned Income Exclusion (FEIE). The housing exclusion uses the housing expenses you have paid throughout the year to increase your FEIE, and lower your income. Due to the higher cost of living in many foreign locations, the IRS created this deduction in order to offset the cost of living outside of the US.
Who Can Take the Foreign Housing Exclusion?
If you meet the requirements of the Foreign Earned Income Exclusion, you may be able to take for the Foreign Housing Deduction. 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?
In order to claim the Foreign Housing Exclusion, you must meet the following conditions:
ONE: 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.
TWO: You must have qualified foreign 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.
THREE: 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.
FOUR: 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. The base amount for your location can be found on the IRS website, Form 2555 instructions, in the last pages of the instructions. 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).
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 which are found in the IRS instructions for form 2555 towards the back.
- 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.
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. However, if you are self-employed in a foreign country and your resident country has a social security totalization agreement with the United States you will not be liable for social security taxes.
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.
About US Tax Practice GmbH: US Tax Practice offers U.S. tax services in Switzerland. It is the go-to tax preparation service and compliance practice for U.S. tax payers. Located in Lenzburg, Switzerland, the company was founded by Patrick Evans, a U.S. tax accountant (CPA, CGMA) and U.S. citizen determined to work with his clients’ best interests in mind. US Tax Practice GmbH services include U.S. Income Tax Preparation, U.S. Tax Compliance, Foreign Bank Account Reporting (FBAR), Tax Planning and Optimization, and Expatriation.