U.S. Taxation: The Housing Exclusion
by George Gonzalez
Are you a U.S. citizen moving to a foreign country for work? If so, read on.
As a U.S. citizen you are subject to taxation of worldwide income regardless of where you live. “Worldwide income” means income from all sources, both U.S. source and foreign source. You must file the annual 1040 tax return If your worldwide income is above the filing requirement threshold (currently approximately $13,000 for single filers and $26,000 for joint filers, although for self-employed individuals there is also an additional threshold). Nevertheless, U.S. citizens who reside on a full-time basis outside of the U.S. are entitled to some tax breaks.
There are three main tax breaks that I discuss in these web pages. In this article I focus on the Housing Exclusion and, in separate articles, the Foreign Earned Income Exclusion and the Foreign Tax Credit.
The Housing Exclusion (HE) is not nearly as well known as the Foreign Earned Income Exclusion (FEIE), which I discuss in another article in these web pages. Nonetheless, the HE is worth knowing about as it can serve to shield an additional amount of foreign employment income, beyond the FEIE exclusion, from income taxation.
If you are self-employed with foreign self-employment income, then you are entitled to the Housing Deduction (HD) rather than the HE. The HD is discussed later in this article.
As with the FEIE, the HE or HD is available only if you meet either the bona fide residence test or the physical residence. (See the article on the FEIE for information on those two tests.)
Housing Exclusion (HE)
The calculations for the HE are complex, considerably more than for the FEIE, because of all the variables that go into the calculations. This article does not get into the minutiae of those details. Rather, the discussion is kept at a general level, and the example presented at the end of this section is kept intentionally uncomplicated.
The concept behind the HE is that you should be entitled to exclude an additional amount of foreign earned income from U.S. taxation, beyond the FEIE exclusion, if the housing expenses where you reside are high. In such situation, the FEIE and the HE work together to potentially allow you to exclude more income from taxation than otherwise would be the case with the FEIE alone.
One of the steps in the calculations is to add up all the qualifying housing expenses that you incurred during the year. Some of the types of expenses that qualify are: rent; the fair market value of housing provided by your employer; foreign real-estate or occupancy taxes; utilities; real or personal property insurance; repairs and maintenance; furniture rental; residential parking. This is a partial list only, but should give you an idea of the types of expenses that qualify for the HE.
Another step in the calculation is to determine the limit on how much in housing expenses you can claim based on where you reside. The IRS publishes the limit amounts based on your location. Here are some examples of the annual limits as published by the IRS for 2022: Lisbon – $43,200; London – $69,500; Mexico City – $47,900; Montreal – $55,500; Panama City – $39,500; Toronto – $63,200; Vancouver – $49,700.
Having established the total housing expenses that you incurred, and the allowable limit based on your location, you proceed with several other calculations that are based on other variables, including the FEIE amount.
Here is a simple example of how the HE can shield foreign earned income from taxation. Assume a U.S. citizen who resides in Vancouver, Canada, meets the bona fide residence test, received foreign employment income of $180,000 and is claiming a FEIE of $120,000 for the year. During the year the individual had qualified housing expenses of $42,000, which is less than the housing expense limit for Vancouver of $49,700 and, therefore, the lesser amount of $42,000 is used in the calculations.
Skipping to the end result of the calculations: the HE amount is $22,800. This, combined with the FEIE of $120,000, yields a total of $142,800. Thus, of the $180,000 in foreign employment income, the individual excludes $142,800 and is taxable on $37,200 ($180,000 less $142,800). Without the HE the individual would have had only a FEIE exclusion of $120,000 and would have been taxable on $60,000 ($180,000 less $120,000). Thus, the HE allowed this individual to shield an additional $22,800 of foreign employment income from taxation.
Housing Deduction (HD)
If you are self-employed and generate foreign self-employment income, you cannot claim the HE (which excludes income), however, you are entitled to the HD (which allows you a deduction). The rules and calculations for arriving at the HD are almost identical to those for the HE, but once you calculate the HD you use it as a deduction against your self-employment income. This is technically different from excluding income, and may not always be as beneficial as an exclusion would have been.
Worth noting is that, although the HD reduces income tax, it does not reduce self-employment tax. Self-employed individuals who work overseas are subject to the same self-employment taxes that fund Social Security and Medicare as are self-employed individuals working in the U.S.; the HD cannot be used to reduce the self-employment income is that subject to the self-employment tax.