What expenses are covered by foreign housing exclusion?
In addition to the foreign earned income exclusion, US expats can also claim foreign housing exclusion. FHE can cover expenses such as rent, utilities, internet, residential parking, brokerage, taxes to secure a leasehold, and rented furniture, as well as any other reasonable expenses incurred from working in a foreign country.
The most important one on the above list is rent, as that can be particularly expensive. How much do people claim?
The amount of FHE that US expats can claim is anything in excess of 16% of the foreign earned income exclusion amount for the year. FHE has a limit, which varies depending on the location where the individual incurred those housing expenses. In the given example of Dubai, the limit is $57,000. The amount of housing expenses the individual can claim for FHE is the lesser of the limit for the location, or the actual expenses incurred, minus the base housing amount of 16% of the foreign earned income exclusion.
Using the Dubai example, how would different housing costs affect the amount of foreign housing exclusion an individual receives?
The IRS view the base housing amount (16% of the foreign earned income exclusion) to be what an individual would be paying for housing in the US, so US expats are only able to claim any extra housing benefits on top of this amount. In the Dubai example, the actual housing expenses for this individual are below the limit for that city of $57,000. Therefore, the individual would receive $40,000 minus the 16% base housing amount ($17,216), which would be approximately $22,700 of FHE.
The IRS will only consider housing expenses up to the limitation for that city, so for the Dubai example that would be $57,000. Therefore, even though the total housing costs are higher, the maximum amount of FHE the individual could receive would be the limit minus the 16% base housing amount, ($57,000 – $17,000), coming to $40,000. However, in this example, the individual will almost certainly be able to take care of the slight additional housing costs after FHE with the leftover amount from the $125,000 salary they receive.
I want more information about Foreign Housing Exclusion
How do you find the foreign housing exclusion limit for the city that you live in?
The FHE limits for different cities can be found on the last page of the instructions for form 2555. If the relevant city is not listed, they also list a generic amount of housing exclusion that you may be able to claim from other high cost locations. It is done by the city rather than the country or region. For example, as previously mentioned, the limit for Dubai is $57,000, whereas, in Abu Dhabi, the limit is $49,000, as the cost of living there is slightly cheaper.
What are the requirements for the Physical Presence Test and the Bona Fide Residence Test?
For the Physical Presence Test (PPT), the individual must be physically present in the foreign country for 330 full foreign days in a period of 12 consecutive months, however those 12 months do not have to be a calendar year. These full days do not include travel days, where for example the individual may arrive from the US at 10am, they must be in the country for the full day for it to be eligible. As the 12 months do not have to be a calendar year, and thus for example the individual could move abroad in July, they may have to file for an extension on their US tax return for that year in order to claim the foreign earned income exclusion and FHE.
For the Bona Fide Residence Test (BFR), the individual must be a bona fide resident of the foreign country for an entire calendar year. Essentially, this means the individual’s work and life must be clearly based in that country, it is their physical and tax home. As the requirement is for a full calendar year, if anyone moves abroad in the middle of the year and wishes to qualify under BFR for FHE, those individuals will almost certainly require an extension to their tax return, and form 2350 is used for this purpose, giving them an automatic extension to January 30th 2022 if they moved abroad in the middle of 2020. Unlike PPT, those wishing to qualify under BFR do not have to monitor days spent in the US during the year. Therefore, for many Americans, BFR is the preferable option to PPT to qualify for FHE, however it is important to ensure that they meet the requirements. This would mean no substantial activity or work in the US, as that would be seen as shifting their tax home. Again, it has to be clear that the individual’s intention is to work and live overseas for more than a year, and their employment must last for longer than a year in order to qualify for the exclusions.
Is the foreign earned income exclusion and foreign housing exclusion something all American expats moving to the Middle East are automatically eligible for?
These exclusions are not automatic for all US expats, there are some requirements that must be met in order to be eligible. Firstly, they must have their tax home in a foreign country, which refers to their main place of employment, or if self-employed, their main place of business must be in the foreign country. Secondly, their employment their must last for longer than a year in that foreign country. Thirdly, expats must meet either the Physical Presence Test, or Bona Fide Residence Test requirements in order to be eligible for FHE. Essentially, it has to be clear that the individual’s intention is to work overseas for more than a year, and their employment does have to last for more than a year, in order for them to qualify for the exclusions.
Contact us at Expat US Tax to have an initial free 20-minute consultation regarding foreign housing exclusion and ways to save you money. We are also able to file tax returns on your behalf should you need it under a pre-agreed fee that won’t be adjusted through the process.