Expat living can be expensive. Therefore, the IRS allows Americans living abroad to offset certain housing costs with the Foreign Housing Exclusion or Deduction. How much expats can save with the exclusion/deduction depends on where in the world they live.
In this article we cover:
- What is the Foreign Housing Exclusion or Deduction?
- Who can claim the Foreign Housing Exclusion or Deduction?
- How much can I exclude?
- How high is the maximum Foreign Housing Exclusion?
- What expenses are eligible for the Foreign Housing Exclusion or Deduction?
- Which housing expenses cannot be excluded or deducted?
- What is the difference between the Exclusion and Deduction?
- How to calculate the Foreign Housing Exclusion?
- How can spouses claim the exclusion?
- Which tax form to use to deduct foreign housing cost?
If you are new to expat taxes, check out our Guide for Expats.
1. What is the Foreign Housing Exclusion or Deduction?
The Foreign Housing Exclusion or Deduction allows US expats to exclude or deduct certain foreign housing expenses from their US taxes. This way, expats can reduce the costs associated with living and working abroad. The Foreign Housing Exclusion or Deduction is requested on IRS Form 2555, the same form that is used for the FEIE.
The amount that expats can exclude or deduct changes each year based on inflation and the city they live in.
2. Who can claim the Foreign Housing Exclusion or Deduction?
Expats must meet the following four requirements to qualify for the Foreign Housing Exclusion:
- Claim the Foreign Earned Income Exclusion (FEIE)
- Establish your tax home in a foreign country
- Pass the physical presence or bona fide residence test
- Have eligible foreign housing expenses that exceed the minimum threshold
3. How much can I exclude?
Expats can only claim eligible expenses that exceed a minimum threshold. This threshold changes every year as it is tied to the Foreign Earned Income Exclusion (FEIE) amount.
The minimum for the Foreign Housing Exclusion or Deduction is set at 16% of the FEIE limit. This means that only housing expenses that exceed those 16%.
For 2019, the FEIE limit is $105,900, and therefore the Foreign Housing minimum is $16,944 in ($105,900 x 16%). Therefore, you can only exclude expenses for 2019 that exceeded $16,944.
However, if you only qualify for the FEIE for part of the year, the threshold for the housing exclusion will be prorated as well.
In addition, there is also a maximum cap on how much you can deduct. The maximum Foreign Housing Exclusion depends on the city you live in.
4. How high is the maximum Foreign Housing Exclusion?
The standard maximum for the Foreign Housing Exclusion or Deduction is 30% of the Foreign Earned Income Exclusion (FEIE). In 2019, the standard maximum therefore is $31,770 ($105,900 x 30%). Again, this is prorated the same way as the FEIE.
Some cities, however, have much higher caps than the standard.
Each year, the IRS publishes a list of selected cities that have extended limits for the Foreign Housing Exclusion or Deduction. Expats who live in these cities can exclude or deduct more, sometimes significantly more, of their housing expenses.
This list includes many cities with high housing costs, such as Singapore, Beijing, Munich, Amsterdam, London, Madrid, and more. These extended limits help US citizens offset the high rents and other housing costs there.
5. What expenses are eligible for the Foreign Housing Exclusion or Deduction?
Reasonable expenses that you paid for or incurred for housing in a foreign country qualify for the exclusion/deduction. Future or expected cost, however, do not qualify. Neither do “lavish” expenses (examples below).
Furthermore, you can only claim housing expenses for the part of the year that you qualify for the Foreign Earned Income Exclusion.
Reasonable housing expenses include:
- Fees for securing a lease
- Property insurance
- Parking spaces
- Rentals for furniture or appliances
- Certain utilities such as water and gas
- Home repairs
Expats can pay for eligible housing expenses through salary, employer reimbursements, or third-party payments on their behalf.
6. Which housing expenses cannot be excluded or deducted?
Housing expenses that are considered lavish or extravagant are not eligible.
Additional expenses that don’t qualify are:
- Cost of buying a property
- Domestic labor (cleaning, cooking)
- Phone bills
- Purchased furniture
- Improvements to a property.
If you are unsure of whether an expense qualifies, you should contact a tax professional to verify.
7. What is the difference between the exclusion and deduction?
Whether to claim an exclusion or deduction depends on the individual’s employment status. Employed expats can claim an exclusion, whereas self-employed expats claim a deduction.
However, there are a few important aspects that employees and self-employed individuals should keep in mind.
The Foreign Housing Exclusion for employees
Employees who are taking the exclusion do not need to pay taxes on the income that went towards the housing expenses.
There are a few ways that employers typically pay for or provide housing for expats.
- If the employer includes funds for housing in the employee’s gross income, then the employee can claim the Foreign Housing Exclusion.
- A company can include the funds designated for housing or as a part of the employee’s regular salary. Either way is acceptable.
- Alternately, if an employee’s housing is required for the job and provided by the employer, the employee can exclude the fair rental value of the property. We see this typically in combat zones and for employees working with natural resources. Other examples are university or government housing.
The Foreign Housing Deduction for self-employed individuals
Self-employed individuals receive a deduction, which helps reduce their overall income tax liability. However, this deduction does not reduce self-employment tax.
If you are self-employed and work from a home office you cannot use the same funds for the Foreign Housing Deduction and the Home Office Deduction. An experienced accountant can analyze whether it would be better to take the foreign housing deduction, home office deduction, or even setting up an accountable expense plan to reimburse home office expenses.
There is a benefit for self-employed expats though. They can carry forward excess expenses and apply them to the next tax year. This carryover is not available for employees.
8. How to calculate the Foreign Housing Exclusion or Deduction?
Calculating the Foreign Housing Exclusion or Deduction is somewhat complex and requires taking several factors into account.
However, as a general overview, the process is as follows:
- Calculate all eligible housing expenses (see above for what qualifies and what doesn’t).
- See if the total exceeds the minimum threshold for Foreign Housing. If it does not, you cannot exclude or deduct those expenses.
- Find the Foreign Housing maximum for your city. If your location is not listed, then the standard maximum applies.
- You can exclude or deduct all expenses exceeding the minimum threshold, up to the listed maximum.
- If your expenses exceed the maximum for your location, you cannot exclude/deduct that excess.
Moving during the tax year
When an expat moves during the year and has expenses from more than one foreign home, they will need to separate their housing expenses for each location. The amount you can exclude or deduct from each location is limited based on the number of days spent there.
The calculation is essentially the same if moving from the US to another country during the same year. The exclusion or deduction amount is limited based on the number of days spent outside of the United States.
9. How can spouses claim the exclusion?
Sometimes, married expat couples maintain separate homes. The living arrangements of spouses though impact the Foreign Housing Exclusion or Deduction.
One Foreign Housing Exclusion for spouses who share a home
If a couple lives abroad in the same home, then only one of them can claim the Foreign Housing Exclusion or Deduction. Likewise, spouses who live together must calculate their housing expenses jointly. This applies whether they file jointly or separately. Generally, the higher income spouse takes all the expenses on their form 2555.
For spouses who live together, there is an especially important rule to be aware of. If they have different lengths of time spent abroad, then they can only deduct expenses for the shorter of the two lengths.
Spouses who maintain separate homes can each claim the exclusion
Many expat spouses live in different cities or even countries. This can occur for a variety of reasons. Some couples live in different locations for their jobs or children’s schooling. Other couples choose to maintain separate homes because one spouse lives and works in a dangerous location.
Spouses who maintain separate homes abroad can often claim the Foreign Housing Exclusion or Deduction separately, on their own returns. To be eligible for this, their homes cannot be within reasonable commuting distance nor in the same tax home.
10. Which tax form to use to deduct foreign housing costs?
The Foreign Housing Exclusion or Deduction is claimed on the same tax form as the Foreign Earned Income Exclusion, Form 2555.
You must file Form 2555 together with your tax return. The filing deadline for expats generally is June 15. Interest for owed tax, however, starts accruing on April 15. Due to the coronavirus pandemic, the IRS extended the deadlines for 2020 to July 15, 2020. As always, if you need more time to file, you can request an extension to October 15.
Need help with your US Taxes?
The Foreign Housing Exclusion or Deduction can result in huge tax savings when living abroad. Still, we see many Americans abroad overlooking this tax savings opportunity. Others don’t calculate it correctly because the pro-rating can be complicated.
These 10 Questions about the housing exclusion hopefully gave you a good overview. Of course, no blog post or internet article can replace the advice of a tax professional who knows your specific tax situation.
If you have additional questions and want help to prepare your tax return, schedule a consultation with one of our expat tax accountants.