What Is “Foreign Housing Exclusion”?

Meaning of “Foreign Housing Exclusion”

In plain English, the foreign housing exclusion is a way to “write off” your rent and utilities when you live overseas. Because the IRS treats housing allowances or direct payments from an employer as taxable income, this exclusion allows you to subtract those specific costs so you aren’t paying income tax on the roof over your head.

This exclusion covers “reasonable” expenses. It isn’t meant for luxury living, but rather for standard housing costs in the location where you are stationed.

Why “Foreign Housing Exclusion” Matters

Living abroad can be expensive, especially in major global hubs. For many expats, the standard Foreign Earned Income Exclusion (FEIE) isn’t enough to cover their total compensation. The housing exclusion is vital because it provides an additional layer of tax savings. By excluding housing costs, you lower your total taxable income, which can move you into a lower tax bracket and significantly reduce your final IRS bill.

How “Foreign Housing Exclusion” Works

To claim this benefit, you must first qualify for the Foreign Earned Income Exclusion by passing either the Physical Presence Test or the Bona Fide Residence Test. Once qualified, the math works like this:

• Qualified Expenses: You can include rent, the fair market value of employer-provided housing, utilities (excluding phone/TV), real and personal property insurance, and certain furniture rentals.
• The “Base Amount” (The Floor): The IRS requires you to pay a certain amount of housing costs out of your own pocket before the exclusion kicks in. This base amount is typically 16% of the maximum FEIE limit.
• The Cap: There is usually a limit on how much you can exclude (often 30% of the FEIE limit), though the IRS provides higher limits for specific “high-cost” cities like Tokyo, London, or Hong Kong.
• Verification: Because these limits and high-cost city lists change annually, you should verify the specific thresholds for your location and tax year.

Simple Example of “Foreign Housing Exclusion”

Imagine you are an employee living in a foreign city where your annual rent and utilities total $35,000. Assume the IRS “base amount” for that year is $20,000.

Your potential exclusion would be the difference: $15,000 ($35,000 minus $20,000). If this $15,000 is within the IRS cap for your city, you can exclude that full $15,000 from your taxable income on top of your standard foreign earned income exclusion.

Who Is Affected by “Foreign Housing Exclusion”?

This provision specifically applies to:

• Employees: Those who receive a salary or housing allowance from an employer. They use the “exclusion” to subtract costs from their income.
• Self-Employed/Freelancers: Technically, they use the Foreign Housing Deduction rather than an exclusion, but the rules and goal are largely the same.
• U.S. Citizens & Resident Aliens: Anyone subject to U.S. worldwide taxation who meets the overseas residency requirements.

Common Mistakes Related to “Foreign Housing Exclusion”

• Including a Mortgage: You cannot exclude mortgage payments, interest, or property taxes. This benefit is strictly for renters.
• Including “Lavish” Expenses: Trying to deduct the cost of a mansion or a private chef. The IRS only allows for “reasonable” costs.
• Including Phone or Internet: While electricity and water count, telephone and television services generally do not.
• Forgetting the “Tax Home”: You cannot claim this if your “tax home” (your main place of business) is still considered to be in the U.S.

Forms Related to “Foreign Housing Exclusion”

To claim the foreign housing exclusion, you must file IRS Form 2555. This is the same form used for the Foreign Earned Income Exclusion. You will fill out Part VI of the form to calculate your housing expenses and the allowable exclusion amount.

“Foreign Housing Exclusion” vs. Related Terms

• Foreign Earned Income Exclusion (FEIE): The FEIE excludes your salary, while the housing exclusion specifically targets housing costs. You usually claim both together.
• Foreign Housing Deduction: This is for self-employed individuals. While the exclusion reduces employer-provided income, the deduction reduces your gross income from self-employment.
• Foreign Tax Credit (FTC): This is a dollar-for-dollar credit for taxes paid to a foreign government. Sometimes, it is more beneficial to use the FTC instead of the exclusion, depending on the local tax rate.

Related Glossary Terms

• Personal property tax
• Excess Social Security Tax Credit
• Modified Accelerated Cost Recovery System
• QTIP trust
• Inventory
• Listed property
• Shareholder basis
• Foreign financial asset
• Deduction for one-half of self-employment tax
• Principal place of business

FAQs About “Foreign Housing Exclusion”

1. Can I use this if I am buying a home abroad?
No. The exclusion is designed for expenses related to renting. Mortgage payments and home purchases do not qualify.

2. What if my employer doesn’t pay my rent directly?
As long as the money you use to pay rent comes from “employer-provided amounts” (your salary or an allowance), you can still claim the exclusion.

3. Does this cover household repairs?
Generally, yes, as long as they are “ordinary and necessary” repairs required for the habitability of the home. It does not cover major renovations.

4. Is there a minimum stay requirement?
Yes. You must meet the same time requirements as the FEIE (usually 330 full days abroad in a 12-month period or a full calendar year of residence).

Final Takeaway

The foreign housing exclusion is a powerful “add-on” to the Foreign Earned Income Exclusion that helps U.S. expats keep more of their income when living in expensive international cities. By allowing you to exclude rent and utilities from your taxable income, the IRS acknowledges that shelter is a major expense when working overseas. If you are an expat, especially in a high-cost area, tracking these expenses meticulously and verifying the current year’s limits for your city is key to maximizing your tax savings.