The Foreign Housing Income Tax Exclusion
U.S. citizens and resident aliens are taxed on their worldwide income. However, U.S. citizens or residents who work and live abroad may qualify to exclude some or all of the amounts paid for their foreign housing costs. For taxpayers who qualify, this exclusion can provide significant tax savings.
Qualifying for the Foreign Housing ExclusionHere is the general rule: the foreign housing exclusion applies only to amounts that are considered paid for with employer-provided amounts for services performed in a foreign country. We*ll go into this rule in more detail below. For now, just know that the exclusion is for housing costs incurred for workers performing services in a foreign country.
In order to be able to claim the foreign housing exclusion the individual must satisfy the following requirements, they must:
1. Have a tax home in a foreign country.
2. Have foreign earned income, i.e., compensation for personal services performed in a foreign country or countries as an employee.
3. Meet either the bona fide residence or physical presence test.
4. Make a valid election to exclude the foreign housing cost amount.
Let*s look at each of these requirements separately.
What is a Foreign Tax Home?A *tax home" is defined as it is in Sec. 162. For readers who aren*t tax pros, Sec. 162 is the Code section that allows taxpayers to deduct business expenses. It is a broad catch-all rule that applies to the majority of business-related deductions. These deductions include the deduction for business-related travel expenses incurred while away from home.
The courts have defined *tax home* for Sec. 162 as "the vicinity of the taxpayer's principal place of employment and not where his or her personal residence is located." So it is the principal place of work.
The foreign housing exclusion modifies this definition by adding that an individual does not have a tax home in a foreign country for any period during which his abode is within the United States.
What is an *abode*? An *abode* is a residence that the individual maintains. It is where they live. An abode is different than a *dwelling.* A dwelling is used by the individual on a less frequent basis.
The abode versus dwelling comes up when the individual maintains more than one dwelling. This may include a dwelling where a spouse and children live. In this situation, the rules say that the maintenance of a dwelling in the United States by an individual, whether or not that dwelling is used by the individual's spouse and dependents, does not necessarily mean that the individual's abode is in the United States.
Moreover, the temporary presence of the individual in the United States does not necessarily mean that the individual's abode is in the United States.
What is a Foreign Country?The term *foreign country* is defined in the regulations. It is a reference to a geographical area that (1) is not a U.S. possession or territory but is (2) subject to the sovereignty of a government other than that of the United States. It also includes the air space over the foreign country. Given this definition, not all overseas locations are *foreign countries.* For example, Antarctica is not a foreign country.
What is Employer-Provided Foreign Earned Income?Employer-provided foreign earned income has also been defined. It is the amount received by the individual from sources within a foreign country or countries which constitute earned income attributable to services performed by the individual.
It does not include payments for the use of property, capital investment, etc. It also does not include income from self-employment.
Examples of employer-provided amounts are wages and salaries, amounts paid by the employer as reimbursement for housing expenses (or rent paid by the employer directly to the landlord), educational expenses of dependents, or amounts received as part of a tax equalization plan.
The Bona Fide Residence RequirementThe courts have developed a number of factors that are to be considered to determine whether an individual satisfies the bona fide resident of a foreign country, including the:
1. Intention of the taxpayer,
2. Establishment of his home temporarily in the foreign country for an indefinite period,
3. Participation in the activities of his chosen community on social and cultural levels, identification with the daily lives of the people and, in general, assimilation into the foreign environment,
4. Physical presence in the foreign country consistent with his employment,
5. Nature, extent and reasons for temporary absences from his temporary foreign home,
6. Assumption of economic burdens and payment of taxes to the foreign country,
7. Status of resident contrasted to that of transient or sojourner,
8. Treatment accorded his income status by his employer,
9. Marital status and residence of his family,
10. Nature and duration of his employment; whether his assignment abroad could be promptly accomplished within a definite or specified time,
11. Good faith in making his trip abroad; whether for purpose of tax evasion.
The courts generally consider and weigh each factor.
The Physical Presence RequirementIf the bona fide resident test is not met, the individual may still qualify for the foreign housing exclusion using the physical presence test. This tests asks whether a citizen or resident of the United States is present in a foreign country or countries during at least 330 full days in such period during any period of 12 consecutive months.
What Housing Expenses Qualify?If these requirements are met, then the individual can exclude their foreign housing expenses. This begs the question: what housing expenses qualify?
Eligible housing expenses have to be paid or incurred in the tax year, they must be reasonable, and they have to be attributable to housing in a foreign country for that individual, his or her spouse, and/or his or her dependents.
These expenses include: Rent, the fair rental value of housing provided by an individual*s employer (provided it was properly included in income), housing repairs (that are not capital expenditures), utilities (other than telephone charges), real and personal property insurance, occupancy taxes, nonrefundable fees for securing a lease, expenses for renting furniture and accessories, and residential parking expenses.
Eligible housing expenses do not include: lavish or extravagant expenses under the circumstances, deductible interest and taxes, the cost of buying property (principal payments on a mortgage), the cost of domestic labor, pay television subscriptions, improvements and other expenses that increase the value or appreciably prolong the life of the property, the expenses of more than one foreign household in some cases, expenses claimed as deductible moving expenses, purchased furniture or accessories, and depreciation or amortization of property or improvements.
Amount of the Foreign Housing ExclusionThe amount that can be excluded under the foreign housing exclusion is the total of the individual*s housing expenses for the year less the base housing amount, which is sixteen percent of the maximum foreign earned income exclusion (*FEIE*) amount. The FEIE amount is adjusted each year. It is $104,100 in 2018.
Additionally, the housing expenses that are eligible to be used in determining the exclusion cannot exceed thirty percent of the maximum FEIE amount, and also cannot exceed an individual*s amount of foreign earned income for the tax year.
Foreign Housing Exclusion vs. Foreign Tax CreditThere are some instances where an individual is better off not taking the foreign housing exclusion. For example, an may opt not to make this election if the foreign country imposes higher taxes on the same income thereby entitling the taxpayer to a foreign tax credit.
The same concept can come up if a tax treaty applies. An individual may not get a double benefit by taking a credit that may be available under a treaty attributable to amounts excluded under the foreign housing exclusion.