For expats moving to high-cost cities such as Dubai, the significant housing expenses must be taken into consideration. In addition to the Foreign Earned Income Exclusion, U.S. expats can also claim for the Foreign Housing Exclusion. The Foreign Housing Exclusion refers to claiming for housing expenses incurred by you, your spouse and/or dependents living with you while living in a foreign country.
QUALIFIED EXPENSES UNDER THE FOREIGN
These expenses must be reasonable but are not limited to rent:
- Residential parking.
- Taxes to secure the leasehold.
- Property insurance.
- Rented furniture, for example, when paying extra for a fully furnished property.
In certain cases where the expat’s family must reside in a separate home abroad (a second foreign household) because the living conditions in the location of the expat’s employment are not safe, the housing expenses incurred for the second household may be eligible for the Foreign Housing Exclusion.
WHAT CAN I CLAIM UNDER THE FOREIGN HOUSING EXCLUSION?
U.S. expats can claim anything in excess of 16% of the Foreign Earned Income Exclusion deemed for that year – the base housing amount. However, it is subject to limit depending on the location where these housing expenses were incurred. It is important to know the limit is different for every city, and these limits can be found in the ‘Instructions for Form 2555’.
Therefore, the amount of foreign housing expenses claimable under the Foreign Housing Exclusion is the lesser of the housing expenses limit of that location, minus the base housing amount.
For example, a U.S. expat is living in Dubai earning a $125,000 USD annual salary and spending $40,000 USD yearly in foreign housing expenses. In Dubai, the limit is $57,000 USD. The housing expenses are below the limit and will be subject to the base housing amount of 16% of the 2020 deemed Foreign Earned Income Exclusion ($17,216 USD). Therefore, they are able to claim $22,784 USD under the Foreign Housing Exclusion.
The base housing amount essentially means that if you were living in the U.S. in 2020, it would cost on average $17,216 USD yearly to live anyway – therefore, you can only claim the expenses exceeding this amount.
If we take a U.S. expat living in Dubai earning a $60,000 USD annual salary and spending $40,000 USD yearly in foreign housing expenses, they cannot claim above the limit of $57,000 USD. Therefore, the base amount of $17,216 USD is deducted from the limit and they can claim $39,784 USD.
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WHICH TEST SHOULD I CHOOSE TO QUALIFY UNDER?
To qualify under the Physical Presence Test, you must spend 330 full foreign days in any 12 consecutive month period. Full foreign days consist of 24 hours strictly beginning at midnight. Days spent travelling are considered as U.S. days and you are given a 35-day limit in the U.S. during this 330-day period. Those planning on travelling to the U.S. whilst qualifying under the PPT should strategically plan the timing of their travels in order to avoid losing out on full foreign days. For example, if arriving from the U.S. into Dubai at 23:50 pm (GST) your full foreign day will begin at midnight – provided that you have established a foreign tax home and residence. However, if arriving at 00:10 am (GST) you will spend just under 24 hours in Dubai, but it will be considered a U.S. day and will not contribute to the foreign day requirement. Even if you fly out to the U.S. for the afternoon, the day will be deducted.
The 12 consecutive month period can begin at any point in the calendar year, but you must wait 330 full foreign days before filing a tax return for the year and will qualify for an automatic extension of two months from the April deadline. You will still receive the exclusions but will have to wait for them.
The Bona Fide Residence Test is an easier option for U.S. expats that offers much more freedom for travel. To qualify under the BFR, a U.S. expat must be a Bona Fide resident of a foreign country for an entire calendar year (January 1 to December 31). An expat moving in the middle of the year, however, will have to wait until January 1. If you want to qualify for exclusion under the BFR but arrive, for example, in Dubai in July 2020, they will use your 2021 tax year as your Bona Fide year. Your 2021 tax year will be used as your Bona Fide tax year under Form 2350 (Application for Extension of Time to File U.S. Income Tax Return), whereby your tax return will be extended until January 30 2022.
When qualifying under the BFR, it is essential to display intent to establish a foreign residence/ tax home for a full calendar year or more. U.S. courts have assessed factors surrounding the nature of the stay, including whether you have been accompanied by your family; whether your house in the U.S. was sold, leased or abandoned; your participation in the foreign community and command of the language. Intending to return to the U.S. after the year should not be of concern, as it does not prevent qualification under the BFR.
Under the BFR you do not have to monitor days spent in the U.S., and you can spend more than 35 days there during the year. Although there is more freedom for travelling to the U.S., expats must be careful to not engage in any substantial activity which will present as shipping their tax home back to the U.S., such as working or earning money in the U.S.
HOW DO I QUALIFY?
It is important to know that the Foreign Housing Exclusion is not automatic. In order to claim you must fill out Form 2555 and include it with your Federal tax Return. In order to qualify for the exclusion, you must adhere to the following requirements:
1. Have a tax home in a foreign country, with an immediate place of business or employment that lasts beyond a year. If you are self-employed, your immediate place of business must be in a foreign country.
2. You must also qualify under either the Physical Presence Test (PPT) or the Bona Fide Residence Test (BFR).
if you can qualify under the BFR you are much better off with no 35-day limit in the U.S. and therefore no monitoring of time spent there. It is less about where you physically are, but where your tax home is. Ensure you not only establish a residence and tax home for at least a full calendar year, but also demonstrate the initial intention to do so.
If you are not able to meet the requirement of a full calendar year, then the PPT may be a better option for you. However, ensure that you strategize your U.S. visits to reduce the deduction of full foreign days.
Contact us at Expat Tax Online to learn more about Foreign Housing Exclusion.