What is the Foreign Housing Exclusion?
The U.S. taxes its citizens and permanent residents on worldwide income, but if you live and work outside the U.S., you may be able to exclude some of your income from taxation using the Foreign Housing Exclusion. For the 2023 tax year the exclusion is $36,000.
The best way to think about the Foreign Housing Exclusion is in conjunction with the Foreign Earned Income Exclusion; in fact, it is calculated based on the Foreign Earned Income Exclusion. If you maxed out the Foreign Earned Income Exclusion (that is, you had more than $120,000 of foreign earned income; 2023 figure) the Foreign Housing Exclusion may allow you to reduce your taxable income further.
Do I Qualify For The Foreign Housing Exclusion?
From the IRS: To claim the foreign housing exclusion you must meet all three of the following requirements:
- Your tax home must be a foreign country.
- You must have foreign earned income.
- You must qualify for the Foreign Earned Income Exclusion under either the Bona Fide Residence test or Physical Presence test.
Basically, you’ll qualify for the Foreign Housing Exclusion if you qualify for the Foreign Earned Income Exclusion (which you can learn more about by reading the blog posts linked above).
What Expenses Qualify for the Foreign Housing Exclusion?
Housing expenses have a broad definition and include reasonable expenses paid or incurred by you, your spouse, or your dependents. The important word in that prior sentence is reasonable. You can’t rent a bunch of Persian rugs, a 10-person sofa, and sign up for a major satellite TV package, and deduct that from your taxes.
Qualifying housing expenses include: rent, repairs, utilities, property insurance, occupancy taxes, fees for securing a lease, rental furniture, and residential parking fees.
Qualifying housing expenses do not include: telephone charges, lavish or extravagant expenses, deductible interest or taxes, the cost of buying a property (including mortgage principal payments), domestic labor, television or cable packages, improvements that increase the value of the property, depreciation, or purchased furniture.
What’s the Difference Between the Foreign Housing Exclusion and Foreign Housing Deduction?
Simple; the exclusion is for employees, while the deduction is for self-employed taxpayers. It’s important to note that for self-employed taxpayers the Foreign Housing Deduction can be used to reduce your income, but it will not reduce the amount of self-employment (Social Security and Medicare) tax that you owe.
Another difference is that nondeductible foreign housing expenses may be carried forward and deducted in the next tax year. In other words, a self-employed taxpayer with qualifying housing expenses that exceed the deductible limit in the current tax year could potentially deduct them the following year and receive a tax benefit. This is in contrast to employees, who must use the Foreign Housing Exclusion and cannot carry forward any unexcluded expenses to the next tax year.
Does My Employer Have to Pay My Housing Expenses Directly to Qualify for the Foreign Housing Exclusion?
Nope. Qualified housing expenses can by paid using your salary, reimbursed by your employer, paid to a third party on your behalf, be part of a tax equalization plan, or be the fair rental value of company-owned housing furnished by your employer.
Is There a Limit on the Foreign Housing Exclusion?
Yes, there is both an upper and lower (base) limit to the Foreign Housing Exclusion. Expenses are not deductible until they exceed the base amount, which is equal to 16% of the maximum Foreign Earned Income Exclusion. For 2023 the maximum Foreign Earned Income Exclusion is $120,000, therefore the base amount before foreign housing expenses become deductible is $19,200 (16% of $120,000).
On the upper end, qualifying expenses are generally limited to 30% of the Foreign Earned Income Exclusion. This means for 2023 the upper limit on qualifying expenses is generally $36,000. Why do I keep saying generally? Because certain high-cost locations qualify for higher upper limits. Hong Kong tops the list in 2023 with an upper limit of $114,300. (For a full list check out the tables starting on page 6 of the instructions for IRS Form 2555.)
Let’s walk through an example of how the two limits work together: Someone in Hong Kong would need $114,300 of qualifying expenses to get the maximum Foreign Housing Exclusion. Their $114,300 in expenses would be reduced by the base amount of $19,200, leaving them with an exclusion of $95,100. Any qualified housing expense above $114,300 and below $19,200 would not be excludable.
And a second example: You’re living in Ecuador and have relatively minimal foreign housing expenses of $20,000. While you won’t have to worry about the upper limit, your exclusion is still reduced by the lower (base) amount of $19,200, leaving you with an exclusion of just $800 ($20,000 – $19,200).
Is My Foreign Housing Exclusion Limited by My Number of Days Abroad?
The upper and lower limits (including the increase for high-cost locations) are annual figures based on a 365-day year (366 if it’s a leap year). If you moved during the year, both limits will be reduced based on the number of days you qualify for the exclusion.
Consider a mid-year example: You moved abroad in November to a non-high cost location that is subject to the base upper limit of $36,000. Because you moved during November, only 45 days during your qualifying period fall within the current tax year. The upper limit of your Foreign Housing Exclusion would be adjusted down to $4,438 [($36,000/365)*45] and the lower limit would be reduced to $2,367 [($19,200/365)*45].
Can I Combine the Foreign Housing Exclusion and the Foreign Earned Income Exclusion?
Yes! U.S. taxpayers that live and work abroad can take advantage of both the Foreign Housing Exclusion and the Foreign Earned Income Exclusion during the same tax year to reduce their taxable income. This means that a single taxpayer could exclude $136,800 of income in 2023 (or more if they live in a high-cost location).
Do Digital Nomads Qualify for the Foreign Housing Exclusion?
Digital nomads can qualify for the foreign housing exclusion, as long as they satisfy the requirements: they must have a foreign tax home, qualifying housing expenses, foreign earned income, and pass either the Physical Presence Test or the Bona Fide Residence Test.
If you lived in more than one foreign location during the year, the calculation gets a bit more complex. You’ll need to calculate the limit for each location in which you incurred qualifying housing expenses, entering the days for each location.
How Does the Foreign Housing Exclusion Work for Married Couples?
Unlike the Foreign Earned Income Exclusion, married couples are generally (there’s that word again) only allowed one Foreign Housing Exclusion:
- If spouses file a joint return and live in the same household, expenses should be combined and then included on either (but not both) Form 2555 to claim the exclusion.
- If spouses have different periods of qualifying time during the tax period (for example, if one moved abroad a little later), unfortunately the form must be completed using the spouse with the shorter (i.e. less advantageous) time period to calculate the qualified exemption.
- If spouses decide to utilize the married filing separate filing status, only one spouse will be entitled to the Foreign Housing Exclusion.
Exception: If spouses live apart and maintain two separate foreign households, they may qualify for twice the exclusion. See below for more details.
What if I Have Multiple Foreign Households?
It is common for individuals living in a high risk or hazardous part of the world to maintain a second, separate household for their family. If the reason you have a second foreign residence is because the first home is dangerous, unhealthful, or otherwise adverse, you can include expenses for the second household. However, keep in mind that while you can include these expenses you are still subject to the same exclusion limitations based off your main place of residence.
Married couples may also find themselves maintaining two separate foreign households because they work in different cities. In this case, they may both independently qualify for the Foreign Housing Exemption and be able to claim qualified expenses under their own separate limitations if their tax homes and households are not within a reasonable commuting distance of each other.
Do You Have Questions About the Foreign Housing Exclusion? Leave them in the Comments Below!
Resources and Tax Forms:
IRS Summary: Foreign Housing Exclusion or Deduction
IRS Form 2555: Foreign Earned Income
IRS Form 2555: Instructions
