Foreign Housing Exclusion and Deduction

In addition to the foreign earned income exclusion, you can also claim an exclusion or a deduction from gross income for your housing amount if your tax home is in a foreign country and you qualify under either the bona fide residence test or the physical presence test.

The housing exclusion applies only to amounts considered paid for with employer-
provided amounts. The housing deduction applies only to amounts paid for with self-employment earnings.

If you are married and you and your spouse each qualifies under one of the tests, see Married Couples Living Apart, later.

Housing Amount

Your housing amount is the total of your housing expenses for the year minus a base amount.

Base amount.   The base amount is 16% of the annual salary of a GS-14, step 1, U.S. Government employee, figured on a daily basis, times the number of days during the year that you meet the bona fide residence test or the physical presence test. The annual salary is determined on January 1 of the year in which your tax year begins.

On January 1, 2002, the GS-14 salary was $67,765 per year; 16% of this amount comes to $10,842 or $29.70 per day. To figure your base amount if you are a calendar-year taxpayer, multiply $29.70 by the number of your qualifying days during 2002. (See Part-year exclusion under Limit on Excludable Amount, earlier.) Subtract the result from your total housing expenses for 2002 to find your housing amount.

Example.   You qualify under the physical presence test for all of 2002. During the year, you spend $13,100 for your housing. Your housing amount is $13,100 minus $10,842, or $2,258.

U.S. Government allowance.   You must reduce your housing amount by any U.S. Government allowance or similar nontaxable allowance intended to compensate you or your spouse for the expenses of housing during the period for which you claim a foreign housing exclusion or deduction.

Housing expenses.   Housing expenses include your reasonable expenses paid or incurred for housing in a foreign country for you and (if they live with you) for your spouse and dependents.

Consider only housing expenses for the part of the year that your tax home is in a foreign country and that you meet either the bona fide residence test or the physical presence test.

Housing expenses include:

• Rent,
• The fair rental value of housing provided in kind by your employer,
• Repairs,
• Utilities (other than telephone charges),
• Real and personal property insurance,
• Nondeductible occupancy taxes,
• Nonrefundable fees for securing a leasehold,
• Rental of furniture and accessories, and
• Residential parking.

Housing expenses do not include:

• Expenses that are lavish or extravagant under the circumstances,
• Deductible interest and taxes (including deductible interest and taxes of a tenant-stockholder in a cooperative housing corporation),
• The cost of buying property, including principal payments on a mortgage,
• The cost of domestic labor (maids, gardeners, etc.),
• Pay television subscriptions,
• Improvements and other expenses that increase the value or appreciably prolong the life of property,
• Purchased furniture or accessories, or
• Depreciation or amortization of property or improvements.

No double benefit. You cannot include in housing expenses the value of meals or lodging that you exclude from gross income (see Exclusion of Meals and Lodging, earlier) or that you deduct as moving expenses.

Second foreign household.   Ordinarily, if you maintain two foreign households, your reasonable foreign housing expenses include only costs for the household that bears the closer relationship (not necessarily geographic) to your tax home. However, if you maintain a second, separate household outside the United States for your spouse or dependents because living conditions near your tax home are dangerous, unhealthful, or otherwise adverse, include the expenses for the second household in your reasonable foreign housing expenses. You cannot include expenses for more than one second foreign household at the same time.

If you maintain two households and you exclude the value of one because it is provided by your employer, you can still include the expenses for the second household in figuring a foreign housing exclusion or deduction.

Adverse living conditions include a state of warfare or civil insurrection in the general area of your tax home and conditions under which it is not feasible to provide family housing (for example, if you must live on a construction site or drilling rig).

Foreign Housing Exclusion

If you do not have self-employment income, all of your earnings are employer-provided amounts and your entire housing amount is considered paid for with those employer-provided amounts. This means that you can exclude (up to the limits) your entire housing amount.

Employer-provided amounts.   These include any amounts paid to you or paid or incurred on your behalf by your employer that are taxable foreign earned income (without regard to the foreign earned income exclusion) to you for the year. Employer-provided amounts include:

1. Your salary,
2. Any reimbursement for housing expenses,
3. Amounts your employer pays to a third party on your behalf,
4. The fair rental value of company-owned housing furnished to you unless that value is excluded under the rules explained earlier at Exclusion of Meals and Lodging,
5. Amounts paid to you by your employer as part of a tax equalization plan, and
6. Amounts paid to you or a third party by your employer for the education of your dependents.

Choosing the exclusion.   You can choose the housing exclusion by completing the appropriate parts of Form 2555. Follow the rules explained earlier in Choosing the Exclusion under Foreign Earned Income Exclusion. You cannot use Form 2555-EZ to claim the housing exclusion.

Your housing exclusion is the lesser of:

• That part of your housing amount paid for with employer-provided amounts, or
• Your foreign earned income.

If you choose the housing exclusion, you must figure it before figuring your foreign earned income exclusion. You cannot claim less than the full amount of the housing exclusion to which you are entitled.

Foreign tax credit. If you claim either the foreign earned income exclusion or the foreign housing exclusion, you cannot take a foreign tax credit for taxes on income you can exclude. If you do take a credit for any of these taxes, one or both of the exclusions may be considered revoked. See Credit for Foreign Income Taxes in chapter 5 for more information about the foreign tax credit.

Foreign Housing Deduction

If you do not have self-employment income, you cannot take a foreign housing deduction.

How you figure your housing deduction depends on whether you have only self-employment income or both self-employment income and employer-provided income. In either case, the amount you can deduct is subject to the limit explained below.

Self-employed - no employer-provided amounts.   If none of your housing amount is considered paid for with employer-provided amounts, such as when all of your income is from self-employment, you can deduct your housing amount, subject to the limit below, in figuring your adjusted gross income.

Take the deduction by including it in the total on line 34 of Form 1040. On the dotted line next to line 34, enter the amount and write Form 2555.

Self-employed and employer-provided amounts.   If you are both an employee and a self-employed individual during the year, you can deduct part of your housing amount and exclude part of it. To find the part that you can take as a housing exclusion, multiply your housing amount by the employer-provided amounts (discussed earlier) and then divide the result by your foreign earned income. The balance of the housing amount can be deducted, subject to the limit below.

Example.   Your housing amount for the year is $12,000. During the year, your total foreign earned income is $80,000, of which half ($40,000) is from self-employment and half is from your services as an employee. Half of your housing amount ($12,000 ÷ 2) is considered provided by your employer. You can exclude $6,000 as a housing exclusion. You can deduct the remaining $6,000 as a housing deduction subject to the following limit.

Limit

Your housing deduction cannot be more than your foreign earned income minus the total of:

1. Your foreign earned income exclusion, plus
2. Your housing exclusion.

Carryover.   You can carry over to the next year any part of your housing deduction that is not allowed because of the limit. You are allowed to carry over your excess housing deduction to the next year only. If you cannot deduct it in the next year, you cannot carry it over to any other year. You deduct the carryover in figuring adjusted gross income. The amount of carryover you can deduct is limited to your foreign earned income for the year of the carryover minus the total of your foreign earned income exclusion, housing exclusion, and housing deduction for that year.

Married Couples Living Apart

If you and your spouse live apart and maintain separate households, you both may be able to claim the foreign housing exclusion or the foreign housing deduction. You can do this if both of the following conditions are met.

• You and your spouse have different tax homes that are not within reasonable commuting distance of each other.
• Neither spouse's residence is within reasonable commuting distance of the other spouse's tax home. Otherwise, only one of you can claim a foreign housing exclusion or deduction.

If you both claim a foreign housing exclusion or a foreign housing deduction, neither of you can claim the expenses for a qualified second foreign household maintained for the other. If one of you qualifies for but does not claim the exclusion or the deduction, the other spouse can claim the expenses for a qualified second household maintained for the first spouse. This would usually result in a larger total foreign housing exclusion or deduction since you would apply only one base amount against the combined housing expenses.

If you and your spouse live together, both of you claim a foreign housing exclusion or a foreign housing deduction, and you file a joint return, you can figure your housing amounts either separately or jointly. If you file separate returns, you must figure your housing amounts separately. In figuring your housing amounts separately, you can allocate your housing expenses between yourselves in any proportion you wish, but each spouse must use his or her full base amount.

In figuring your housing amount jointly, you can combine your housing expenses and figure one base amount. If you figure your housing amount jointly, either spouse (but not both) can claim the housing exclusion or housing deduction. However, if you and your spouse have different periods of residence or presence and the one with the shorter period of residence or presence claims the exclusion or deduction, you can claim as housing expenses only the expenses for that shorter period.

Example.   Tom and Jane live together and file a joint return. Tom was a bona fide resident of and had his tax home in Ghana from August 17, 2002, through December 31, 2003. Jane was a bona fide resident of and had her tax home in Ghana from September 15, 2002, through December 31, 2003.

During 2002, Tom received $75,000 of foreign earned income and Jane received $50,000 of foreign earned income. Tom paid $10,000 for housing expenses, of which $7,500 was for expenses incurred from September 15 through the end of the year. Jane paid $3,000 for housing expenses in 2002, all of which were incurred during her period of residence in Ghana.

Tom and Jane can choose to figure their housing amount jointly. If they do so, and Tom claims the housing exclusion, their housing expenses would be $13,000 and their base amount, using Tom's period of residence (Aug. 17 - Dec. 31, 2002), would be $4,069 ($29.70 × 137 days). Tom's housing amount would be $8,931 ($13,000 - $4,069). If, instead, Jane claims the housing exclusion, their housing expenses would be limited to $10,500 ($7,500 + $3,000) and their base amount, using Jane's period of residence (Sept. 15 - Dec. 31, 2002), would be $3,208 ($29.70 × 108 days). Jane's housing amount would be $7,292 ($10,500 - $3,208).

If Tom and Jane choose to figure their housing amounts separately, then Tom's separate base amount would be $4,069 and Jane's separate base amount would be $3,208. They could divide their total $13,000 housing expenses between them in any proportion they wished.

Housing exclusion.   Each spouse claiming a housing exclusion must figure separately the part of the housing amount that is attributable to employer-provided amounts, based on his or her separate foreign earned income.

Form 2555 and Form 2555-EZ

You can use Form 2555 to claim the foreign earned income exclusion. You must use it to claim the foreign housing exclusion or deduction. In some circumstances you can use Form 2555-EZ to claim the foreign earned income exclusion.

You must attach Form 2555 to your Form 1040 or 1040X if you claim the foreign housing exclusion or the foreign housing deduction. If you cannot use Form 2555-EZ, you must attach Form 2555 if you claim the foreign earned income exclusion. Form 2555 shows how you qualify for the bona fide residence test or physical presence test, how much of your earned income is excluded, and how to figure the amount of your allowable housing exclusion or deduction. Do not submit Form 2555 or Form 2555-EZ by itself. See the instructions for the forms if you are not sure about the information requested.

Form 2555-EZ

Form 2555-EZ has fewer lines than Form 2555. You can use this form if all seven of the following apply.

1. You are a U.S. citizen or a resident alien.
2. Your total foreign earned income for the year is $80,000 or less.
3. You have earned wages/salaries in a foreign country.
4. You are filing a calendar year return that covers a 12-month period.
5. You did not have any self-employment income for the year.
6. You did not have any business or moving expenses for the year.
7. You are not claiming the foreign housing exclusion or deduction.

Form 2555

If you claim exclusion under the bona fide residence test, you should fill out Parts I, II, IV, and V of Form 2555. In filling out Part II, be sure to give your visa type and the period of your bona fide residence. Frequently, these items are overlooked.

If you claim exclusion under the physical presence test, you should fill out Parts I, III, IV, and V of Form 2555. When filling out Part III, be sure to insert the beginning and ending dates of your 12-month period and the dates of your arrivals and departures, as requested in the travel schedule.

You must fill out Part VI if you are claiming a foreign housing exclusion or deduction.

Fill out Part IX if you are claiming the foreign housing deduction.

If you are claiming the foreign earned income exclusion, fill out Part VII.

Finally, if you are claiming the foreign earned income exclusion, the foreign housing exclusion, or both, fill out Part VIII.

If you and your spouse both qualify to claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction, you and your spouse must file separate Forms 2555 to claim these benefits. See the discussion earlier under Married Couples Living Apart.

Illustrated Example

Jim and Judy Adams are married and have two dependent children. They are both U.S. citizens and they file a joint U.S. income tax return. Each one has a tax home in a foreign country and each meets the physical presence test for all of 2002. They both can exclude their foreign earned income up to the limit.

Jim is a petroleum engineer. He works primarily in the Persian Gulf region. For 2002, his salary, which was entirely from foreign sources, amounted to $71,000. In addition, his employer provided him an annual housing allowance of $18,000, which he used to maintain a rented apartment at his tax home in Country X for the period he was not working at remote drilling sites.

At various times during the year, Jim worked at remote oil drilling sites in nearby countries. While he worked at these remote sites, his employer provided him lodging and meals at nearby camps. Satisfactory housing was not available on the open market near these drilling sites, and the lodging was provided in common areas that normally accommodated 10 or more employees and were not available to the general public. The fair market value of the lodging he was provided in these camps was $2,000, and the value of the meals was $1,000.

After he made an adequate accounting, Jim was reimbursed by his employer for part of his travel expenses and other employee business expenses. Jim had $2,500 of unreimbursed employee business expenses for travel, meals, and lodging that were allocable to his foreign earned income.

Because of adverse conditions in Country X, Judy and the children lived in Paris, France, while Jim worked in the Middle East. Judy had a job as an executive secretary with a U.S. company in Paris. Her earnings from this job were $44,000. These earnings were subject to French income tax.

The Adams family rented an apartment in Paris during 2002 for Judy and the children. They paid $1,000 a month rent, including utilities, or $12,000 for the year. The Adamses choose to treat the expenses for the Paris apartment as those for a qualified second foreign household. They include the $12,000 Paris housing expenses with Jim's $18,000 Country X housing expenses. This results in a larger total housing exclusion.

Jim and Judy had taxable U.S. interest income of $7,500 for the year. The Adamses had no other income for the year and do not itemize deductions.

The Adamses report their income and figure their foreign earned income exclusions and foreign housing exclusion, as shown on the accompanying filled-in forms.

First, they list their income on the front of Form 1040. Their combined salaries, including Jim's $18,000 housing allowance, total $133,000. They enter this on line 7. They enter their interest income of $7,500 on line 8a.

At this point, Jim will complete Form 2555 and Judy will complete Form 2555-EZ to figure their foreign earned income and housing exclusions.

Jim's Form 2555.   On Jim's Form 2555, Part IV, he lists his salary on line 19, his housing allowance on line 22e, and the fair market value of meals and lodging provided in camps by his employer on lines 21a and 21b. The entries on lines 21a and 21b are not shown as income on Form 1040. Jim enters the total of these two entries on line 25 of Form 2555.

Jim combines his housing expenses, $18,000, with the qualified expenses for the second household, $12,000, and enters total housing expenses of $30,000 on line 28. He puts a base amount of $10,842 on line 30 and subtracts that amount to arrive at a total foreign housing amount of $19,158 on line 31. He figures a housing exclusion of $19,158 on line 34.

Although Judy could claim a separate housing exclusion for the expenses of the Paris apartment rather than combining those expenses with Jim's housing expenses, she does not do so because she would have to reduce her expenses by a separate base housing amount. Also, her foreign earned income is less than the maximum foreign earned income exclusion, so claiming a separate housing exclusion would not result in any tax benefit.

Jim figures his foreign earned income exclusion in Part VII of Form 2555. Because his foreign earned income is more than the maximum exclusion of $80,000, he must reduce the income by the housing exclusion. The foreign earned income exclusion on line 40 is $69,842 ($89,000 - $19,158).

When Jim combines this exclusion of $69,842 with his housing exclusion of $19,158 he comes up with a total exclusion of $89,000 in Part VIII.

The Adamses cannot deduct any of Jim's unreimbursed employee business expenses because they are all allocable to excluded income. However, the Adamses are still entitled to the full standard deduction for a married couple filing jointly.

Judy's Form 2555-EZ.   Judy completes a Form 2555-EZ to figure her foreign earned income exclusion. Her foreign earned income is less than the maximum excludable amount. On Judy's Form 2555-EZ, Part IV, she lists her salary on line 17. She figures an exclusion of $44,000 on line 18.

The Adamses enter their combined exclusions of $133,000 on line 21, Form 1040. They identify this item to the left of the entry space. Their adjusted gross income on line 35 is $7,500, their investment income, which does not qualify for exclusion.

Form 1040, Adams

Form 2555, page 1 for James Adams

Form 2555, page 2 for James Adams

Form 2555, page 3 for James Adams

Form 2555-EZ, Adams

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