Many U.S. citizens may choose to live abroad for personal and professional reasons. Also, they may choose to move abroad temporarily or permanently. From a taxation perspective, all these decisions have implications. Essentially, the United States taxes its citizens on worldwide income, which means if you are a U.S. citizen, you must file a tax return even if you live overseas.
However, you can claim the foreign housing exclusion to avoid double taxation, provided you meet specific criteria. In this guide, we will discuss in detail the foreign housing exclusion, who qualifies for it, and how you can claim this deduction.
What is the Foreign Housing Exclusion?
The Foreign Housing Exclusion is a tax provision that falls under Section 911 of the IRS Code. As the name suggests, this option allows taxpayers to claim certain housing-related deductions from their gross income. The primary goal of this deduction is to reduce the burden of maintaining a house in foreign countries, where the cost of living can be much higher than in the United States.
How It Helps U.S. Expats Save on Taxes
The Foreign Housing Exclusion allows taxpayers to deduct qualified housing expenses, like rent, utilities, and insurance premiums, from their gross income. For example, if you earn $150,000 a year in London and pay $50,000 as rent and utilities, you can deduct them, so taxes are calculated only on the remaining $100,000. This option allows taxpayers to retain more of their income. It’s important to note that the amount that can be deducted must be the actual amount spent on housing in a foreign country and is subject to the limits set by the IRS.
Who Qualifies for This Exclusion
To qualify for this exclusion, an individual taxpayer must meet one of the two critical tests set by the IRS – the Bona Fide Residence Test and the Physical Presence Test.
As per the Bona Fide Residence Test, an individual must be a resident of a foreign country throughout the entire tax year without any interruptions. You are allowed to visit the U.S. or any other country for a temporary period, but you must have a clear intent to return to your foreign country.
The Physical Presence Test, on the other hand, requires you to have been physically present in a foreign country for at least 330 full days during a 12-month period.
Additionally, you must have earned income in the foreign country during the tax year and paid for your living expenses with that income. Note that the U.S. government employees, including military personnel, do not qualify for this exclusion, as their salaries are paid by the U.S. government.
Key Housing Expenses That Count
Not all housing expenses can be claimed under this provision. The IRS lays down the following items as qualified housing costs:
- Rent paid for any residence in a foreign country where the taxpayer is staying.
- Utilities paid, like electricity, water, sewer, and gas.
- Any property or home insurance.
- The non-refundable costs of leasing and administrative expenses.
- Any furniture repair or rentals.
The IRS specifically excludes home improvements, mobile or telephone charges, domestic labor, and the expenses incurred for purchasing a property. Also, the IRS updates the maximum amount that can be claimed based on the cost-of-living expenses of the foreign country where you are residing. Anything more than this money cannot be claimed.
How to Claim the Foreign Housing Exclusion?
Since the IRS has stringent requirements, you must understand the IRS code and follow the procedures closely to claim this deduction. Otherwise, it can lead to errors or even worse, fines and penalties.
Using IRS Form 2555 for the Exclusion
Form 2555 is the form used for reporting foreign earned income and claiming deductions, including the Foreign Housing Exclusion. This form requires you to provide details of your foreign residence, like address, employer information, type of visa you hold in that country, date of residence, and more.
You can get this form online or from your tax preparer. Once you fill out the form, submit it to the IRS along with Form 1040. The deadlines for filing income tax returns apply to this form as well.
Step-by-Step Calculation of Your Allowable Amount
To calculate the eligible amount under the Foreign Housing Exclusion, follow the steps below:
- As a first step, determine the costs associated with your foreign housing. This can include rent, utilities, and insurance.
- In the next step, you must subtract the base housing amount. This is 16% of the maximum Foreign Earned Income Exclusion for a given year, divided by 365 (366 if it’s a leap year), multiplied by the number of days in your qualifying period in that year.
- There is a limit on the maximum amount you can claim as deductible. For 2024, this is set at $126,500 per person. If two individuals who are married and work abroad meet the eligibility criteria, they can claim a maximum deduction of $253,000 for the 2024 tax year, provided they file jointly.
- Based on the above rules, your base housing amount is 0.16 X 126,500 = $20,240 as Foreign Housing Exclusion. For those married and filing jointly, the amount is $40,480.
- Finally, every city and country has a maximum housing limit based on the living costs of that place. For example, if the housing limit in your city is $40,000, and your yearly housing expenses are $35,000, then your housing exclusion is $35,000 – $20,240 = $14,760.
- Note that you can claim only up to the limit approved by the IRS, even if your actual costs are higher. In the above example, if your actual costs are $45,000, you can still use only the approved limit of $40,000. The calculation will be, $40,000 – $20,240 = $19,760.
Common Mistakes to Avoid When Filing
Many taxpayers lose these benefits because of a lack of awareness and wrong calculations. Also, sometimes, miscalculations can warrant IRS audits, and even fines and penalties, adding to the tax burden. Some common mistakes to avoid when filing are:
- Claiming personal or non-qualifying expenses, like home improvements and furniture repairs.
- Using incorrect exchange rates for conversion.
- Not maintaining proper receipts and documentation.
- Not qualifying or misrepresenting the physical presence or bona fide residence tests.
- Claiming expenses for time spent in the U.S.
To prevent these mistakes and the consequences that come with them, consider hiring the services of a professional tax consulting firm like Manay CPA.
Limits and Important Rules
As mentioned earlier, there are many limits and rules associated with the Foreign Housing Exclusion. Here are a few important ones to keep in mind.
Maximum Housing Exclusion for Different Locations
The IRS sets maximum limits for different cities, based on the living costs prevailing in them. For example, cities like Tokyo and London have higher limits as they are more expensive, while many Eastern European and Asian cities have lower limits. The IRS updates this limit each year, so it’s important to check the limits for the relevant tax year.
How Self-Employment or Other Income Affects Eligibility?
The limits and claims discussed so far apply to employer-generated income only. For those who are self-employed, the calculations are slightly different. For starters, self-employed individuals cannot claim the Foreign Housing Exclusion. Instead, they can only claim the Foreign Housing Deduction.
Though the terms are different, the computation does not change much. The limits for housing costs in different, and the base amount remains the same. A key difference is that your foreign housing deduction cannot be more than the foreign income earned, and this is a deduction from your income and not an exclusion.
Another difference is that the foreign housing exclusion must be calculated before the foreign earned income exclusion. Also, you cannot claim any other foreign tax credit. When it comes to foreign housing deduction, the housing costs reduce your taxable income for income tax only, and do not impact the self-employment tax, which remains the same. For example, if you have an income of $100,000 and housing costs of $40,000, your self-employment tax of 15% is calculated on $100,000, while the income tax is calculated on the remaining $60,000. On the other hand, in a foreign housing exclusion, there’s no self-employment tax, so the income tax is calculated at $60,000.
Interaction With the Foreign Earned Income Exclusion
The Foreign Earned Income Exclusion (FEIE) is closely related and can be used to exclude a wide range of foreign earned income from taxes to avoid double taxation. There is a limit for FEIE as well, and for 2025, it is $130,000. On the other hand, the Foreign Housing Exclusion applies only to housing costs. In other words, FEIE is a broader pool, which also includes the Foreign Housing Exclusion.
How Manay CPA Can Help with Your Foreign Housing Exclusion
Tax rules for expatriates are complex and technical. There are high chances for wrong filings, which can increase your financial burden. In some cases, you may even miss out on eligible deductions. To avoid these scenarios, Manay CPA’s team of experienced tax preparers works with you to understand your situation and guide you accordingly.
Accurate Preparation and Filing of Form 2555
One of the highlights of Manay CPA’s service is the accuracy in tax preparation. Every CPA in this firm is well-versed with the IRS codes, and they always stay on top of the yearly and periodical changes. All this means they can maximize your deductions for a financial year. Additionally, they can help with the preparation and filing of Form 2555, which deals with foreign-earned income.
Personalized Guidance for Complex Expat Situations
When you settle abroad, you are likely to have multiple business and financial interests across countries, and this can get complicated while filing your U.S. taxes. Moreover, the process is different based on the nature of your work. For example, self-employed individuals have a different set of rules when compared to employer-generated income.
Manay CPA can tailor tax strategies to meet your specific needs. They analyze your residency status and the nature of your employment to assess whether you qualify for FEIE and housing benefits. They also help understand if you must exclude or deduct housing costs and the process for doing the same. In short, they take the burden of complex computations from your shoulders and ease the tax filing process for you.
Schedule a Free Consultation
If you have questions about your eligibility or do not have the time to pore through IRS guidelines and calculate taxes, reach out to Manay CPA today, as they can take care of the end-to-end tax filing for you. The team will work with you to maximize your reductions while ensuring compliance with taxation laws.
FAQs
Can I claim housing exclusion if I live in a country with a high cost of living?
Yes, but your exclusion amount cannot exceed the amount set by the IRS for that specific city. Note that these limits may change every year, depending on the prevailing cost of living.
What expenses are specifically excluded by the IRS?
IRS specifically excludes the purchasing cost of a property, mortgage payments, domestic labor, home improvements, furniture purchases, home repairs, and television or telephone costs. It only includes rent, utilities, and home insurance payments.
How does partial-year foreign residency affect eligibility?
If you live abroad for a part of a year and still meet the 330-day physical presence requirement, you can claim a partial deduction. This amount is prorated based on the number of days you have stayed overseas during the said tax year.
Can married couples claim separate housing exclusions?
Yes, if both spouses meet the qualifying criteria and file taxes separately. Each spouse must file a separate Form 2555 and claim housing expenses separately. If one spouse does not meet the requirements, then only the other person can claim these deductions or exclusions.
Is there a deadline to file for housing exclusion after moving abroad?
The exclusion must be claimed before the regular income tax filing deadline. The IRS automatically grants a two-month deadline for expats, which means the tax filing date is June 15.
