36.4 How To Treat Housing Costs

The housing costs of employees and self-employed persons are treated differently by the tax law. Employees get a housing exclusion; self-employed persons get a deduction from taxable foreign earned income. If you live in a special camp provided by your employer, all housing costs are excluded; see 36.8.

Exclusion for employer-financed housing costs.

The housing exclusion is the excess of the employer-financed reasonable housing expenses (see below) over a “base housing amount.” The daily base housing amount is 16% of the maximum foreign earned income exclusion, prorated for the number of your qualifying days of foreign residence or presence for the year. Thus, for 2012, the base housing amount is $15,216 ($95,100 maximum foreign earned income exclusion × 16%) if you qualify under the foreign residence or physical presence test for the entire year. If you qualify under the residence or presence test for only part of the year, the $15,216 maximum base amount is prorated on a daily basis, so $41.57 ($15,216 ÷ 366) is allowed for each qualifying day in 2012.

Filing Tip

Claiming the Housing Exclusion

On Form 2555, you figure the housing exclusion before the foreign income exclusion. The income exclusion is limited to the excess of foreign earned income over the housing exclusion.

- - - - - - - - - -

In figuring housing expenses in excess of the base housing amount, there is a limit on the expenses that can be taken into account. Generally, the housing expenses cannot exceed 30% of the maximum earned income exclusion, prorated as applicable by the number of qualifying days of foreign residence or presence for the year. Thus, for 2012, the limit on housing expenses is generally $28,530 (30% × $95,100), or $77.95 per day, and the maximum housing exclusion is generally $13,314 ($28,530 − $15,216 maximum base amount). However, the expense limit, and thus the exclusion, may be significantly more than this if you are working in a high cost locality. The IRS can raise the annual limit for housing expenses in expensive foreign areas. The adjusted limits will be provided in a table included in the instructions to Form 2555.

On Form 2555, your foreign earned income exclusion is limited to the excess of your foreign earned income (including employer-financed housing costs) over your housing exclusion.

Reasonable housing expenses.

Include rent, utilities other than telephone costs, insurance, parking, furniture rentals, and repairs for yourself, your spouse, and dependents living with you. The following expenses do not qualify: cost of purchasing a home, furniture, or accessories; home improvements; payments of mortgage principal; domestic labor; and depreciation on a home or on improvements to leased housing. Furthermore, interest and taxes that are otherwise deductible do not qualify for the exclusion.

You may include the costs of a separate household that you maintain outside the U.S. for your spouse and dependents because living conditions at your foreign home are adverse.

Self-employed persons.

On Form 2555, self-employed individuals may claim a limited deduction for housing costs exceeding the base housing amount. You may claim this deduction only to the extent it offsets taxable foreign earned income. The deduction is claimed as an “adjustment to income” on Line 36 of Form 1040, even if you do not itemize deductions.

Where you may not deduct expenses because you do not have taxable foreign earned income, expenses may be carried forward one year and deducted in the next year to the extent of taxable foreign earned income.

If you are an employee and self-employed during the same year.

Housing expenses above the base amount are partly excludable and partly deductible. For example, if half of your foreign earned income is from services as an employee, half of the excess housing expenses over the base amount are excludable. The remaining excess housing costs are deductible to the extent of taxable foreign earned income. Follow the instructions to Form 2555.

Countries ineligible for tax benefits.

Housing expenses incurred in a country subject to a U.S. government travel restriction are not eligible for the tax benefits explained in this section. See Form 2555 instructions for a list of countries to which travel restrictions apply.