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How does the foreign housing exclusion or deduction work?
In addition to the foreign earned income exclusion, you also can claim an exclusion (for salaried) or a deduction (for self-employed) from your gross income for your housing expenses.
You must qualify for the foreign earned income exclusion, and only amounts paid for with employer-provided funds may be excluded. This does not mean that your employer must pay the housing expenses directly- it only means that the monies used must be traced back to the employer in some fashion. For example, Emirates Airlines defines which portion of your pay is earmarked for housing.
Housing expenses include rent, fair rental value of housing provided in kind by your employer, repairs, utilities (other than telephone), insurance, parking, among other items.
Housing expenses do not include expenses that are lavish or extravagant, deductible interest and taxes, cost of buying property including principal payments, domestic labor (maid, gardeners, etc.), improvements that increase the value or prolong the life of property, purchased furniture or depreciation.
The base housing amount is 16% of the eligible amount of foreign earned income exclusion. For example, if you are able to exclude the maximum for 2014 or $99,200, the base amount is $15,872 or $43.48 per day. This amount is the portion that cannot be excluded- think of it as the money you would typically have spent on housing in the United States.
Note: There are scenarios where claiming the foreign housing exclusion or deduction is not to your advantage because of the base housing amount. Generally speaking, if your total income is within 16% of the foreign earned income exclusion allowed, you should not take the foreign housing exclusion or deduction.
There is also a limit on housing expenses. The amount of qualified housing expenses eligible for the housing exclusion and housing deduction is generally limited to 30% of the maximum foreign earned income exclusion computed on a daily basis (for 2014, this would be 30% of $99,200 or $29,760, or $81.53 per day). However, the limit can vary wildly depending upon the location of your foreign tax home.
In 2006, the IRS, Treasury Department along with the State Department began recognizing that certain locations carry a much higher cost of living, and therefore needed to be factored into expatriate and per diem calculations. There are over 400 countries and specific cities that are deemed high-cost areas. The latest list is detailed in IRS Notice 2014-29.
For example, London is considered a high-cost city (no kidding) and carries a maximum exclusion of $88,700 or $243.01 per day for 2014. Wow! So, normally you would be limited to $29,760, or $81.53 per day, but if you live in London your daily housing exclusion or deduction increases to $243.01. Nice!
Here is a comparison of a high-cost city and a garden-variety city, and how the foreign housing exclusion differs. You might want to freshen up your beverage- here we go!
|2||Qualified Housing Expense||45,000||45,000|
|3||Housing Expenses Allowed||45,000||29,760|
|4||Base Amount Not Allowed||15,872||15,872|
|5||Foreign Housing Exclusion||29,128||13,888|
|6||Foreign Income Exclusion||99,200||99,200|
In each example, the taxpayer had $45,000 in qualified housing expenses shown on line 2. This amount was allowed under the London column but was limited to $29,760 under the ‘other city’ column which is shown on line 3.
The first 16% of the maximum foreign earned income exclusion is not allowed to be excluded. For 2014 this is 16% x $99,200 or $15,872 as shown on line 4. So the allowable foreign housing exclusion is reduced as shown on line 5. We’re not done yet, there’s more.
Your foreign earned income is now reduced by the amount shown on line 5. So with our ExPat living in London if she earns $100,000 USD she can only exclude $70,871 ($100,000 less $29,128). Yet if she earns $150,000 USD then she can exclude the full allowable amount for 2014 or $99,200. Make sense? Again, this presumes that the earnings have been divided between income and housing.
Other notables include Paris at $86,000 and Moscow rounding out the list at $108,000. You can see the entire list of countries in IRS Notice 2014-29 (a list of several prior years can be found at the bottom of this article). Interesting to note that Dubai is no longer on the list, and Paris and Tokyo went down. Currency exchange has shifted slightly perhaps.
Another big takeaway here is that foreign housing exclusions and deductions are always broken down into a value per day, and the multiplied by the days living abroad.
If you are self-employed, the foreign housing deduction (as opposed to exclusion) applies to you, and the computations above remain applicable. However, as a self-employed taxpayer, you can carry over any part of your housing deduction that is limited (and not allowed) to the next year. If you cannot deduct it next year, you cannot carry to any other year.
Married couples can have some unique situations and may be allowed to exclude or deduct the expenses of two separate households.