How to Claim the Housing Deduction on Form 2555

U.S. citizens and resident aliens living abroad may reduce their U.S. income tax liability by claiming a benefit for their housing costs. This tax relief, the foreign housing deduction, is designed to offset the financial burden of maintaining a residence in a foreign country. The deduction is calculated using Form 2555, Foreign Earned Income, which is filed with your annual U.S. income tax return. This benefit is for self-employed individuals, while the similar foreign housing exclusion is available to employees.

Determining Your Eligibility for the Housing Deduction

Before you can calculate any potential tax savings, you must first meet a set of foundational requirements, starting with the tax home test. Your tax home is the general area of your main place of business or post of duty, regardless of where you maintain your family home. To qualify for the housing deduction, your tax home must be located in a foreign country for an uninterrupted period that includes an entire tax year.

Once the tax home test is met, you must also satisfy one of two additional tests: the bona fide residence test or the physical presence test. The bona fide residence test applies to a U.S. citizen who is a genuine resident of a foreign country for an uninterrupted period that includes a full tax year. The IRS looks at factors like the nature and length of your stay and your intentions regarding residency.

The physical presence test applies to either a U.S. citizen or a U.S. resident alien who has been physically present in a foreign country for at least 330 full days during any 12-consecutive-month period. These 330 days do not need to be consecutive.

Identifying Qualified Foreign Housing Expenses

After establishing eligibility, the next step is gathering the costs that constitute your total qualified foreign housing expenses. These are the reasonable expenses paid for housing in a foreign country for you, your spouse, and any dependents who live with you. Allowable expenses include:

• Rent paid for a property
• The fair rental value of housing provided by an employer if you include it in your income
• Repairs that do not add to the property’s value
• Utilities, such as electricity and heat, but not telephone, internet, or television services
• Real and personal property insurance
• Occupancy taxes or leasing fees required
• Rental of furniture and accessories
• Residential parking

Just as important is understanding what expenses are disallowed. The IRS does not permit the inclusion of costs that are “lavish or extravagant under the circumstances.” Disallowed expenses include:

• The cost of purchasing a home, such as mortgage principal payments
• Capital improvements that increase the property’s value or prolong its life
• The costs of purchased furniture or domestic labor like maids or gardeners
• The value of meals

Calculating the Allowable Housing Deduction

The calculation of the foreign housing deduction is a multi-step process that starts with your total qualified foreign housing expenses. From this total, you must subtract a “base housing amount,” as only expenses exceeding it are eligible for the deduction.

The base housing amount is directly tied to the maximum Foreign Earned Income Exclusion (FEIE). The base is 16% of the maximum FEIE amount. For tax year 2024, the maximum FEIE is $126,500, which sets the annual base housing amount at $20,240. This figure must be prorated for the number of days in your qualifying period.

After determining your expenses above the base amount, you must consider the overall limit. Generally, your housing expenses cannot exceed a limit of 30% of the maximum FEIE. However, the IRS publishes higher limits for numerous high-cost cities, such as the 2024 limit for Hong Kong of $114,300. You must consult the Instructions for Form 2555 for your location’s limit.

Your potential deduction is your total qualified housing expenses minus the base housing amount. The final allowable deduction is the lesser of this resulting figure or the overall limit for your specific foreign location. For instance, if your qualified expenses are $45,000, your base amount is $20,240, and your location’s limit is $39,700, your potential deduction is $24,760 ($45,000 – $20,240). Since $24,760 is less than the $39,700 limit, your allowable deduction is $24,760.

Claiming the Deduction on Form 2555

It is important to distinguish between the housing deduction and the housing exclusion. The deduction is for self-employed individuals and applies to amounts paid for with self-employment earnings. The exclusion is for employees whose housing is paid for with employer-provided funds.

Both are calculated on Form 2555, but the deduction is specifically handled in Part VI. You will use the figures from your calculation to complete the lines in this section, which guides you to enter your total qualified housing expenses, the applicable limit, and the base housing amount.

The housing deduction you calculate on Form 2555 is carried over to Schedule 1 (Form 1040), Additional Income and Adjustments to Income. This transfer incorporates the deduction into your overall tax calculation, reducing your adjusted gross income. Your total foreign earned income for the year imposes a final limitation on the deduction.