How to Claim the Foreign Housing Exclusion or Deduction

U.S. citizens and resident aliens living and working abroad may be able to reduce their U.S. income tax by accounting for higher housing costs. The tax law provides two benefits: the foreign housing exclusion and the foreign housing deduction. These benefits are closely linked to the Foreign Earned Income Exclusion (FEIE).

The foreign housing exclusion is available to taxpayers who have housing costs paid for with employer-provided funds, such as a salary or a housing allowance. In contrast, the foreign housing deduction is for self-employed individuals who cover their own housing expenses. It is possible for a taxpayer to claim both in the same year if they have both employment and self-employment income.

Eligibility Requirements

To claim either the foreign housing exclusion or deduction, a taxpayer must first meet the requirements for the Foreign Earned Income Exclusion. This involves satisfying the tax home test and either the bona fide residence test or the physical presence test.

The tax home test requires that your main place of business or employment is in a foreign country. An assignment abroad must be indefinite or for a substantial period; temporary assignments that last for a year or less do not qualify to establish a foreign tax home.

The bona fide residence test centers on being a legitimate resident of a foreign country for an uninterrupted period that includes a full tax year, from January 1 to December 31. This does not mean you cannot take brief trips back to the U.S., but you must have the clear intention of residing in the foreign country. For example, someone who moves to France on a long-term contract and rents an apartment would likely meet this test after living there for a complete tax year.

Alternatively, the physical presence test is based on the number of days spent in a foreign country. A taxpayer must be physically present in one or more foreign countries for at least 330 full days during any consecutive 12-month period. A full day is a continuous 24-hour period. For instance, if a contractor works in Germany and is physically there from March 1, 2024, through February 10, 2025, they would meet the 330-day requirement.

Identifying Qualified Housing Expenses

Qualified housing expenses are the reasonable costs necessary to provide housing for you and, if they live with you, your spouse and dependents in a foreign country.

Allowable expenses include:

• Rent paid for a property
• The fair rental value of housing provided by an employer
• Utilities such as electricity, gas, and water
• Renter’s or property insurance
• Necessary repairs
• Rental of furniture and accessories
• Fees for securing a lease
• Residential parking for a car at your home

Certain costs are explicitly disallowed. The cost of purchasing a home, making capital improvements, or buying furniture is not a qualified expense. Expenses for domestic labor, such as maids or gardeners, are also excluded. Any costs that are considered lavish or extravagant under the circumstances are not permitted; for example, renting a five-bedroom villa for a single person would likely be deemed extravagant.

Calculating Your Exclusion or Deduction

The calculation of your foreign housing amount begins with your total qualified housing expenses, which are then measured against a specific threshold and a limit. The first component is the base housing amount. This is a threshold your housing expenses must exceed, calculated as 16% of the maximum Foreign Earned Income Exclusion (FEIE) for that year. This base amount must be prorated for the number of days in your qualifying period within the tax year.

Your housing expenses are also subject to an overall limit, which is 30% of the maximum FEIE. However, the IRS recognizes that housing costs vary significantly and publishes a list of high-cost localities where a higher limitation applies. Taxpayers in cities like Hong Kong or Tokyo may use a higher expense limit, allowing for a larger benefit.

The final calculation subtracts the base housing amount from your total qualified housing expenses. The result is your potential housing amount, subject to the overall limit. If an employee has $30,000 in qualified expenses and their prorated base amount is $20,800, their housing amount is $9,200. This amount is an exclusion from income, but it cannot exceed their total foreign earned income for the year.

For a self-employed individual, the result is a deduction. If a consultant has $30,000 in qualified expenses and a $20,800 base amount, their housing amount is $9,200. This amount is taken as a deduction, but it is limited to the taxpayer’s foreign earned income minus their FEIE and any housing exclusion they might also be claiming.

Filing Your Claim with Form 2555

Claiming the foreign housing exclusion or deduction requires filing Form 2555, Foreign Earned Income, with your U.S. tax return. Before starting the form, you should gather all necessary information. This includes your foreign address, your employer’s name and address, and detailed records of your travel dates to and from the United States to prove you meet the physical presence or bona fide residence test. You will also need a complete and itemized list of your qualified housing expenses paid during the year.

The form guides you through listing your total qualified housing expenses, entering the annual limitation for your specific foreign location, and calculating your base housing amount to arrive at your final exclusion or deduction.

After you have completed Form 2555, you must file it with your annual U.S. income tax return, Form 1040. The final amounts you calculated are reported on Schedule 1 of Form 1040, “Additional Income and Adjustments to Income.” The foreign housing exclusion is included in the total amount reported on line 8d, and the foreign housing deduction is reported separately on its designated line.

You can submit your tax return with Form 2555 attached either electronically or by mail. Most e-filing software platforms support Form 2555. If you file by mail, place Form 2555 behind Schedule 1.