The Foreign Housing Exclusion
The foreign housing exclusion, or FHE, is one of the tax breaks available for US expats to reduce any US tax liability on income earned from living and working abroad. This article gives you an overview of what the FHE is, who can claim it, and how you can claim it.
What is the FHE?
The foreign housing exclusion is a special deduction that US expats living and working abroad can use to reduce the amount of their foreign wages that are subject to US tax. The FHE was created to offset expenses US expats incur while living overseas.
The FHE works in conjunction with the foreign earned income exclusion (the FEIE) by excluding a portion of your foreign wages (up to a limit) as wages that are subject to US tax.
What is the amount of the FHE?
The amount of the FHE depends on where you live and incur eligible housing expenses. There is a “floor” and a “ceiling” to the FHE amounts.
The FHE floor
The FHE floor is $17,216 for 2020. Foreign housing expenses you incurred that are below this amount will not be eligible for the FHE.
The FHE ceiling
The FHE ceiling, or limit, is generally $32,280 for 2020. If you live in a high-cost location, the FHE is adjusted upwards based on amounts provided by the IRS. For example, if you live in Hong Kong, your FHE ceiling is $114,300 for 2019!
Who can claim the FHE?
The FHE has the same basic eligibility rules or “tests” as the FEIE, described below.
Tax home test
First of all, you must have a tax home that is located outside of the US. Your tax home is generally the area of your main place of employment, regardless of where you maintain your family home. If you expect your employment away from the US to last more than a year, then your tax home is generally considered to be in that foreign country. Most expats who live and work in a foreign country will be considered to have a tax home in that foreign country. Many expats maintain a home and family in the US but are still considered to have a tax home in a foreign country.
Secondly, your tax home must be located outside of the US during your period of either bona fide residence or physical presence abroad. In other words, you must have a tax home abroad and meet either the bona fide residence test, or the physical presence test, either or!
Bona fide residency test
To meet the bona fide residence test, you must have established your “residency” in a foreign country. Typically, you begin your bona fide residence period the day you moved abroad. Your bona fide residence ends the day you move back to the US. You must have been a bona fide resident of a foreign country for an entire tax year, so if you established bona fide residency in or before 2018, and are still a resident of a foreign country in 2020, then you are considered a bona fide resident because you were outside of the US for a full calendar year (2018). You remain a bona fide resident until establishing residency back in the US For example, if you moved abroad during 2019, then you will not qualify as a bona fide resident unless you continue to live abroad through the end of 2020.
Physical presence test
The physical presence test is best for US expats working and living abroad temporarily. The physical presences test does not require you to live abroad for a full calendar year. The only requirement is that you spend 330 out of 365 days abroad over a 12 month period. Note, this 12 month period does not have to be a calendar year, the 12 month period can be any period that either begins or ends in the tax year you want to qualify for the physical presence test! be in a calendar year, either.
Finding out which test is best for you can be complicated, so we built Expatfile to automatically recommend what you should choose just by answering a few simple questions about your life abroad!
Which housing expenses qualify for the FHE?
Foreign housing expenses that qualify for the FHE basically include any reasonable expenses incurred by you to maintain a foreign household. This includes rent, utilities, real and personal property insurance, nonrefundable fees paid to obtain a lease, rental of furniture and accessories, residential parking, and household repairs.
Purchases of furniture or mortgage interest to purchase a foreign home will not count as a qualifying expense for the FHE.
How do you claim the FHE?
To claim the FHE, you need to file Form 2555 and attach this to your filed expat tax return. If you are married or green card holder, and both you and your spouse are working and living abroad, then only one of you can claim the FHE unless you live apart from each other.
Form 2555 can be complicated to an expat that is starting from scratch – so we built Expatfile to immediately determine and fill out Form 2555 for you! Answer a few questions and Expatfile’s expat tax software does the rest.
Do you have an example of how the FHE works?
Here’s a simplified example of how the FEIE works:
- You’re filing your 2019 US federal tax return and your filing status is “single”.
- You earned foreign wages of $180,000 while living and working in Singapore.
- You paid $80,000 in qualifying housing expenses while living in Singapore.
- Let’s assume you would owe $60,000 in US federal taxes on this income.
- On your foreign wages, you actually paid $40,000 in Singapore taxes.
Of the $180,000 of your foreign wages, you can exclude up to $105,900 from being subject to US taxes by using the FHE. In addition, you can claim $65,956 of housing expenses by using the FHE (The ceiling for Singapore is $82,900 less the floor of $16,944). This brings your wages subject to US tax down to $8,144. The 2019 standard deduction for a taxpayer claiming the “single” filing status is $12,200 (everyone gets this), meaning your taxable income would be $0. You would not owe any US taxes on the foreign wages you earned while living and working in Singapore!
What type of foreign income can the FHE be used for?
Similar to the FEIE, the FHE can be used to exclude “foreign earned income” from being subject to US tax. What this means for most expats is that they can use the FEIE to exclude foreign wage income or foreign self-employment income, from being subject to US tax.
The FHE can even be used to exclude wages paid to you by a US employer, subject to meeting the eligibility tests described earlier!
The FEIE can not be used to exclude foreign income from interest, dividends, or capital gains.
Can self-employed expats claim the FHE?
Good question! US expats who are self-employed and living abroad can claim something very similar to the FHE, the foreign housing deduction (the FHD). The FHD works very similarly to the FHE with the same eligibility requirements.
I am paid by a US employer but I live and work abroad, does the FHE still work for me?
Yes, absolutely. The source of your wages is not the decisive factor in determining your eligibility to claim the FHE. Many US expats are still on the payroll of US companies. In fact, many US expats are subject to US tax withholding. The good news is, if you meet the eligibility requirements described above, you can get a refund for US tax withholding!
Note: if you are paid by a US employer, they will still withhold Medicare and social security taxes from your paychecks. These amounts can not be refunded to you, even if you claim the FHE.
Should I always use the FEIE, or should I claim the foreign tax credit (the FTC)?
If you live and work abroad in a country where the foreign tax rate is higher than the US federal tax rate, then you are usually better off by claiming the FTC. Claiming the FTC is a much more simple process than claiming the FEIE, and it also opens you up to other tax breaks in the US like the child tax credit.
Generally, if you live in a country where the foreign tax rate is lower (or zero) than the US federal tax rate, then you are usually better off by claiming the FEIE.
Some benefits of claiming the FTC over the FEIE include:
- If you claim the FEIE in a given year and you want to switch to FTC in a future year, you may not be able to claim the FEIE for 5 years unless you receive special persmissiom from the IRS to do so.
- If you paid more foreign taxes than US federal taxes, you can carry forward these as a credit to future years.
- If you claim the FEIE, you cannot claim the Additional Child Tax Credit (a refundable tax credit of up to $2,000 per child per year). If you claim the FTC, you are allowed to take this credit.