The foreign housing exclusion is a tax benefit that allows U.S. taxpayers who work and live abroad to exclude certain housing expenses from their taxable income. These expenses may include rent, utilities, insurance, and other reasonable costs associated with maintaining a foreign residence. The exclusion is generally limited to 30% of the foreign earned income exclusion.
To be eligible for the foreign housing exclusion, taxpayers must have foreign earned income and meet either the Physical Presence Test or the Bona Fide Residence Test. Taxpayers can choose to use either the Bona Fide Resident Test or the Physical Presence Test, whichever works best for their specific situation. However, they cannot use both tests in the same tax year.
The foreign housing exclusion is separate from the foreign earned income exclusion, which allows U.S. taxpayers to exclude a certain amount of income earned while working abroad from their taxable income. However, taxpayers must meet the eligibility requirements for both exclusions to take advantage of them.
The IRS has several requirements for filing a foreign housing exclusion. They include:
- You must have foreign earned income: To be eligible for the foreign housing exclusion, you must have foreign earned income. This includes wages, salaries, or self-employment income earned while working in a foreign country.
- You must meet either the Physical Presence Test or the Bona Fide Residence Test: To claim the foreign housing exclusion, you must also meet one of these two tests. The Physical Presence Test requires you to have been physically present in a foreign country for 330 full days during a 12-month period. The Bona Fide Residence Test requires you to have established a bona fide residence in a foreign country.
- Your housing expenses must be paid with foreign earned income: To qualify for the foreign housing exclusion, your housing expenses must be paid with foreign earned income. You cannot use housing expenses paid with other types of income, such as U.S. earned income or investment income.
- Your housing expenses must be considered reasonable: The IRS determines what is considered reasonable housing expenses based on the location where you are living. You cannot claim expenses that are considered excessive.
- You must file Form 2555 or Form 2555-EZ: To claim the foreign housing exclusion, you must file either Form 2555 or Form 2555-EZ with your tax return. These forms allow you to calculate and claim the exclusion.
- You must keep accurate records of your housing expenses: It’s important to keep detailed records of your housing expenses, including receipts and invoices. You may be required to provide these records to the IRS if they request them.
If the IRS determines that you have used the foreign housing exclusion improperly, you may be subject to a penalty of up to 20% of the underpayment of tax. This penalty is in addition to any interest that may be assessed on the underpaid taxes. These penalties and interest can add up quickly, so it’s important to make sure you are using the exclusion correctly. Additionally, if the IRS determines that you have willfully and knowingly claimed the foreign housing exclusion incorrectly, you may be subject to criminal penalties, including fines and imprisonment.
It’s important to note that the rules and regulations for claiming the foreign housing exclusion can be complex. If you have any questions or concerns, it’s always a good idea to consult with a tax professional.
