How can the Foreign Housing Exclusion benefit US expats?
Published on January 03, 2024
by Jonathan Rose, EA
Jonathan Rose, an IRS Enrolled Agent with 13 years of expat tax experience, specializes in US tax preparation, tax planning, and tax advice for US citizens and Green Card holders living and working in Australia.
Jonathan also talked about family tax benefits in Australia.
Table of Contents
What is the Foreign Housing Exclusion (FHE)?
The FHE is a tax provision designed to help US expats. If your tax home is in a foreign country, you can exclude or deduct some of your housing expenses from your gross income. Why is this helpful? It eases the financial burden of maintaining a home abroad.
The FHE works alongside the Foreign Earned Income Exclusion (FEIE), another tax break that lets you exclude part of your foreign-earned income. How do they work together? You can claim the FHE in addition to the FEIE, which provides you with a broader range of financial relief.
Who qualifies for the Foreign Housing Exclusion?
To be eligible for the FHE, you need to meet certain criteria. You must pass either the bona fide residence test or the physical presence test, which looks at your ties and time spent in the foreign country and your intent to return to the US
There are also income limits for the FHE. Your foreign housing amount is your total housing expenses for the year minus a base amount, which is linked to the maximum foreign-earned income exclusion.
What’s the cap? It varies based on your location and can’t be more than your total foreign-earned income for the year.
We understand that dealing with US tax laws while living abroad can be tricky. That’s why we recommend talking to a tax professional when encountering complex tax issues. They can offer advice that’s right for your situation.
What housing expenses are covered by the FHE?
The FHE lets you exclude certain housing costs from your income. However, what exactly counts as a housing expense? The IRS says eligible expenses include reasonable costs paid or incurred for housing in a foreign country for you and your dependents, like rent, utilities, and repairs.
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What costs aren’t covered by the FHE?
Not everything falls under the FHE. You can’t exclude costs like buying property, furniture, or home accessories. But what else is excluded? Expenses that add value or significantly extend the life of your property also don’t count. Additionally, the value of meals and employer-provided lodging that’s not part of your gross income can’t be included as housing expenses.
What’s the formula for calculating the Foreign Housing Exclusion?
Figuring out your FHE amount involves a few steps. First, you take your total foreign housing expenses for the year and subtract the base housing amount.
How do you find this base amount? It’s 16% of the maximum foreign earned income exclusion, divided by 365, then multiplied by the number of days in your qualifying period within the tax year.
For 2023, the base amount is $19,200.
What if my housing expenses are less than the limit?
Let’s say you’re like Sarah, an expat in Nassau, who chooses a modest apartment and spends $23,000 on housing for the year. The FHE limit for Nassau is $49,700.
To calculate Sarah’s taxable income, subtract the base rate ($19,200) from the FHE limit ($49,700), giving a maximum claim of $30,500. Then, subtract Sarah’s actual expenses ($23,000) from this maximum claim. Sarah’s taxable income is $7,500, which will be considered for the Foreign Housing Limit.
If your expenses are below the base rate, you won’t pay US tax on any income assigned to housing expenses. This can lead to tax benefits, financial freedom, and reduced stress due to lower expenses.
What if I exceed the Foreign Housing Exclusion limit?
Consider David, an expat in Hong Kong, who spends $140,000 on a luxury apartment. The FHE limit for Hong Kong is $114,300, but after subtracting the base amount ($19,200), his maximum claim is $95,100.
Subtracting this from his total expenses, David has overspent by $44,900. This excess amount won’t be covered by the FHE, increasing his taxable income and potentially causing financial strain.
What does the Foreign Housing Exclusion mean for investments and emergency funds?
The Foreign Housing Exclusion (FHE) is all about reducing your tax bill on housing costs while you’re working abroad. It’s not a direct way to put money into investments or emergency savings. But, if you’re spending less on housing than your FHE limit, you could indirectly use the savings for investments or building an emergency fund. This isn’t a direct feature of the FHE, though; it’s more about smart budgeting and planning.
By using the FHE, you might lower your overall tax liability. The cash you save on taxes could then go into investments or an emergency fund. And knowing you’re saving on taxes might make you feel more comfortable putting money into riskier investments.
Can I claim both the Foreign Housing Exclusion and deduction?
It depends on your situation. The FHE is for costs covered by employer-provided funds, while the housing deduction is for self-employment earnings. You’ll need to look at your job status and income sources to decide which one to go for.
How should I report the Foreign Housing Exclusion on my tax return?
You’ll need to use Form 2555 to report your foreign-earned income and housing costs. Plus, you’ll summarize your income, deductions, and credits on Form 1040, your standard tax return form. Keep all your housing bills and receipts, like rent and utilities, and have proof of your employment status abroad.
Is the Foreign Housing Exclusion Different for Employees and Self-Employed Individuals?
Yes, there are some differences. For employees abroad, the FHE is for costs covered by your employer. You can’t use a foreign tax credit or deduction for income you exclude under the FHE. For self-employed expats, the housing deduction is for costs paid with self-employment earnings. Your housing deduction can’t be more than your foreign earned income minus your foreign earned income exclusion and any housing exclusion you’ve claimed.
What Are the Limits and Restrictions of the Foreign Housing Exclusion?
When using the Foreign Housing Exclusion (FHE), it’s important to know its limits. Your housing expenses can’t go over a certain amount, which varies based on where you live. If your costs exceed this limit, the extra amount won’t be covered by the FHE.
For high-income earners, there’s another rule to keep in mind: your foreign housing expenses can’t be more than your total foreign-earned income for the year. This is especially relevant if you have high housing costs.
Does living in a high-cost area affect my FHE?
Living in a high-cost area can be a mixed bag. While it often means a higher standard of living, it can also strain your wallet. If you’re in a pricier location, the IRS might adjust your exclusion limit upwards. This can be a big help, potentially increasing the amount you can exclude.
Can I use the FHE if I’m working part-time or intermittently abroad?
Yes, you can still claim the FHE if you’re working part-time overseas, but the amount you can exclude will be adjusted according to your work schedule. If you’re working abroad intermittently, you’ll need to meet either the bona fide residence or physical presence test to qualify for the FHE.
What records should I keep for my FHE claim?
Keeping thorough documentation is paramount. Hold onto all your housing-related bills and receipts, like rent, utilities, and repairs. Also, keep proof of your employment status abroad, such as contracts or pay stubs.
How does the FHE impact my overall tax liability?
The FHE doesn’t just help with housing costs; it also affects your total tax liability. By excluding certain housing expenses, it reduces your taxable income, which could lower your overall tax bill.
For intricate tax matters, talking to a tax professional is a smart move. They can offer personalized advice, making sure you’re taking full advantage of financial benefits and staying compliant.
The information provided herein is for general informational purposes only and should not be considered professional advice. While we aim to provide helpful and accurate information, we make no warranties or guarantees about the accuracy, completeness, or adequacy of the information contained here or linked to from this material.
Always get professional advice from a US international tax specialist.
