It is well known that U.S. taxpayers who live abroad and have earned income, such as salaries and compensation for personal services, may benefit from the Foreign Earned Income Exclusion (‘FEIE’), assuming they meet the relevant tax home and bona fide residence (or physical presence) tests (please refer to our previous article, “Tax Benefits While Working Outside of the U.S.”.
Additionally, if an employer provides compensation for housing costs, taxpayers can also claim the foreign housing exclusion (‘FHE’) for qualifying foreign housing expenses. Self-employed taxpayers, on the other hand, can claim the foreign housing deduction (‘FHD’).
What are qualified housing expenses?
Housing expenses include reasonable expenses actually paid or incurred for housing in a foreign country for you and – if they lived with you – for your spouse and dependents, such as rent, utilities, real and personal property insurance, etc. However, expenses like buying or improving a house and payments for deductible interest and taxes do not qualify. Additionally, housing expenses do not include expenses that are lavish or extravagant.
How to calculate the FHE?
To calculate the FHE, taxpayers need to be aware of both the ceiling and the floor limits for deductible expenses. Generally, the ceiling is set at 30% of the maximum Foreign Earned Income Exclusion (FEIE). For the tax year 2024, this is $37,950 (30% of $126,500). However, this limit can vary depending on the location where the housing expenses are incurred, with the IRS providing specific annual limits for different locations. The floor, or minimum threshold, for 2024 is $20,240. Any foreign housing expenses incurred below this amount are not eligible for exclusion.
To illustrate, below is a simplified example of how the FHE works:
- Taxpayer A has foreign-earned wages of $140,000 and received $60,000 compensation for foreign housing expenses while living and working in Dubai in 2024. Thus, total 2024 gross compensation is $200,000.
- Taxpayer A met (or will meet) the tax home test and either the bona fide residence or physical presence test for tax year 2024.
- Taxpayer A used $60,000 for qualified housing expenses.
From the total compensation of $200,000, Taxpayer A can exclude up to $126,500 by using the foreign earned income exclusion (FEIE). In addition, Taxpayer A can claim $36,934 of housing expenses by using the foreign housing exclusion (FHE) (the ceiling for Dubai is $57,174 less the floor of $20,240). Taxpayer A’s total FEIE and FHE is $163,434, thus reducing their U.S. compensation income to $36,566 ($200,000 less $163,434).
Where to claim the FHE and FHD?
To claim the foreign housing exclusion or the foreign housing deduction, taxpayers need to complete Form 2555 and attach it to an originally filed Form 1040 or an amended Form 1040-X. U.S. expats who are self-employed and living abroad can claim a foreign housing deduction on Form 2555, which is similar to a foreign housing exclusion.
In cases where both the taxpayer and their spouse are living and working abroad, both can claim the Foreign Earned Income Exclusion, but only one can claim the Foreign Housing Exclusion or Foreign Housing Deduction unless they live apart.
Summary
The foreign housing exclusion (or deduction), in addition to the foreign earned income exclusion, are useful tools for taxpayers living and working abroad to reduce their U.S. tax liabilities. However, as with all tax planning, taxpayers should take into account other considerations, such as the use of foreign tax credits and obtaining U.S. tax residency certificates, to name a few.
Please contact us or your WilkinGuttenplan tax advisor for additional questions or concerns.
