Clark Stott has been with Expat Tax Online since 2015. Being a dual national based in the UK, Clark has unique experience helping US citizens (and Accidental Americans) become tax compliant via the Streamlined Tax Amnesty program. Clark likes to help Americans in the UK keep their tax situations as simple as possible to avoid harsh IRS treatment.
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The FHE is a provision that allows you to exclude or deduct a portion of your housing expenses from your gross income if your tax home is in a foreign country. So, what’s exactly the purpose of the FHE? It alleviates the financial burden of maintaining a residence abroad.
Additionally, the FHE complements the Foreign Earned Income Exclusion (FEIE), another provision that allows you to exclude a certain amount of your foreign-earned income. How do these two interact? Essentially, the FHE can be claimed in addition to the FEIE, providing a more comprehensive financial relief strategy for U.S. expatriates.
Who is eligible for the Foreign Housing Exclusion?
Eligibility for the FHE is tied to certain criteria. You must qualify under either the bona fide residence test or the physical presence test. These tests evaluate your ties to the foreign country where you’re living, such as the duration of your stay and your intentions to return to the U.S.
Income limitations also apply when claiming the FHE. Your foreign housing amount is calculated as the total of your foreign housing expenses for the year minus a base housing amount. This base amount is tied to the maximum foreign-earned income exclusion. So, what’s the limit? The limit varies depending on your location and cannot exceed your total foreign-earned income for the taxable year.
Experiencing the complexities of U.S. tax laws while living abroad can be a daunting task. For more intricate tax matters, it’s often wise to consult a tax professional. They can provide expert advice tailored to your unique situation.
What housing expenses can be excluded under the FHE?
The FHE allows you to exclude certain housing expenses from your gross income. But what exactly qualifies as a housing expense? According to the IRS, reasonable expenses actually paid or incurred for housing in a foreign country for you and your dependents are eligible. This includes rent, utilities, and repairs.
What expenses are not eligible for the FHE?
Not all expenses can be excluded under the FHE. For instance, the cost of buying property, purchased furniture, or accessories are not eligible. What else is off the table? Expenses that increase the value or appreciably prolong the life of your property are also not included. Additionally, the value of meals and employer-provided lodging not included in your gross income can’t be counted as housing expenses.
How do I calculate the Foreign Housing Exclusion amount?
Calculating the FHE can be a bit tricky. Your foreign housing amount is the total of your foreign housing expenses for the year minus your base housing amount. How is this base amount determined? It’s tied to the maximum foreign earned income exclusion and is calculated as 16% of this maximum amount divided by 365, then multiplied by the number of days in your qualifying period that fall within your tax year. For 2023, that magic number is $19,200.
What happens if I spend less than my Foreign Housing Limit?
Let’s talk about a hypothetical scenario: imagine Sarah, an expatriate working in Nassau. She opts for a modest apartment in Nassau and manages her expenses carefully. Her total foreign housing expenses for the year amount to $23,000.
The Foreign Housing Exclusion for Nassau is $49,700.
In order to find Sarah’s taxable income, we deduct $19,200 (Base Rate) to $49,700 (Foreign Housing Exclusion). Now, we have Sarah’s maximum claim, which is $30,500.
Next, we deduct Sarah’s $30,500 (Maximum Claim) to $23,000 (Total Foreign Housing Expenses. Sarah’s taxable income is $7,500, which will be put towards the Foreign Housing Limit.
It’s important to remember that in order to claim the foreign housing exclusion, your expenses must exceed the Base Rate ($19,200).
In this case, Sarah has underspent her total foreign housing expenses. This could be advantageous for her in several ways:
- Tax Benefits: Since her expenses are below the maximum limit, she won’t pay US tax on any of her income that is assigned to housing expenses.
- Financial Freedom: The money saved could be allocated to other financial goals, such as investments or emergency funds.
- Reduced Financial Stress: Lower expenses generally mean less financial burden, allowing Sarah to live more comfortably within her means.
What happens if I spend more than the exclusion?
Let’s imagine another hypothetical scenario, someone spends more than the Foreign Housing Exclusion amount for the city they’re living in. Meet David, an expatriate in Hong Kong.
He decides to live in a luxurious apartment in the city center, resulting in foreign housing expenses of $140,000 for the year.
Since he’s living in Hong Kong, his housing limit is $114,300. However, we will need to deduct it with the base amount of $19,200, which makes the calculated housing limit, David’s maximum claim, $95,100. (See Table)
Now, we deduct $95,100 (Maximum Claim) to $140,000 (Total Foreign Housing Expenses). This means that David has overspent by $44,900.
This could have several implications:
- Tax Liabilities: The excess amount will not be eligible for the foreign housing exclusion, increasing his taxable income.
- Financial Strain: Such high expenses could put a dent in his savings and limit his financial flexibility.
What it means for investments or emergency funds
The Foreign Housing Exclusion (FHE) is specifically designed to reduce the tax burden on qualifying housing expenses when you’re living and working abroad. Remember, it’s not a fund or an account where you can directly allocate money for investments or emergency savings.
- Indirect Benefit: If you’re underspending compared to the calculated housing limit, the money you save on housing expenses could indirectly be used for investments or building an emergency fund. However, this is not a direct function of the FHE; it’s a result of effective budgeting and financial planning.
- Tax Savings: By taking advantage of the FHE, you could reduce your overall tax liability. The money saved from lower taxes could then be channeled into investments or an emergency fund.
- Financial Planning: If you know you’ll save a certain amount on taxes through FHE, you might be more comfortable allocating funds to riskier investments.
Can I claim both the Foreign Housing Exclusion and the Foreign Housing Deduction?
The answer depends. While the FHE applies to amounts considered paid for with employer-provided amounts, the housing deduction applies only to amounts paid for with self-employment earnings. So, how do you choose? You’ll need to weigh the benefits of each based on your employment status and income sources.
How do I report the Foreign Housing Exclusion on my tax return?
You’ll need specific forms and documentation. The primary form used for reporting foreign-earned income and housing costs is Form 2555. Additionally, you’ll summarize your income, deductions, and credits on your standard tax return form, Form 1040. As for documentation and record-keeping, it’s crucial to keep all your bills and receipts for rent, utilities, and repairs. You should also maintain documentation that proves your employment status abroad.
Is there a difference between the FHE for employees and self-employed individuals?
There are some key differences. For employees working abroad, the FHE applies only to amounts considered paid for with employer-provided amounts. Moreover, you can’t take a foreign tax credit or deduction for taxes on income you can exclude. On the other hand, for self-employed expatriates, the housing deduction applies only to amounts paid for with self-employment earnings. Your foreign housing deduction cannot be more than your foreign earned income less the total of your foreign earned income exclusion, plus your housing exclusion, if any.
Are there any limitations or restrictions on the Foreign Housing Exclusion?
When it comes to the FHE, there are certain limitations and restrictions you should be aware of. For instance, your housing expenses may not exceed a specific limit, which varies depending on your location. So, what happens if your housing expenses go overboard? Well, any housing expenses exceeding the maximum limit won’t be eligible for the FHE.
But wait, what about high-income earners? Are there special rules for them? Indeed, there are. The IRS states that foreign housing expenses may not exceed your total foreign-earned income for the taxable year. This is particularly relevant for high-income earners who might have substantial housing costs.
What if I live in a high-cost foreign location?
Living in a high-cost foreign location can be both a blessing and a curse. On one hand, you get to experience a higher standard of living; on the other, it can be a financial burden. So, are there any additional considerations for expatriates in high-cost areas? Absolutely. The IRS allows for potential adjustments to the exclusion limit based on the cost of living in your specific location. This means you might be eligible for a higher exclusion amount, which can be a financial lifesaver.
Can I claim the Foreign Housing Exclusion if I work part-time or intermittently abroad?
The IRS has specific guidelines for this. If you’re working part-time abroad, you can still claim the FHE, but your exclusion amount will be prorated based on your work schedule. For those working intermittently abroad, you must meet either the bona fide residence or physical presence test to qualify for the FHE.
What documentation should I keep to support my FHE claim?
Documentation is important when it comes to taxes. So, it’s crucial to keep all your bills and receipts for rent, utilities, and repairs. Additionally, it’s imperative to maintain documentation that proves your employment status abroad, such as employment contracts or pay stubs.
How does the Foreign Housing Exclusion affect my overall tax liability?
The FHE doesn’t just offer a break on housing costs; it also has implications for your overall tax liability. So, how does it impact your taxable income? The FHE reduces your taxable income by excluding certain housing expenses, which could potentially lower your overall tax liability.
It’s often wise to consult a tax professional. They can provide expert advice tailored to your unique situation, ensuring you’re not missing out on any financial benefits.
The information provided herein is for general informational purposes only and should not be considered professional advice. While we aim to provide helpful and accurate information, we make no warranties or guarantees about the accuracy, completeness, or adequacy of the information contained here or linked to from this material.
Always get professional advice from a US international tax specialist.
