Digital Nomad Tax Guide Part II - The Foreign Housing Exclusion

An Introduction

Technically the foreign housing exclusion is just a part of the foreign earned income exclusion (FEIE). If you missed our Part I blog on the FEIE, make sure to give that a read here.

For simplicity, I’m separately the two concepts and giving them entirely different names and sections. The Foreign Housing Exclusion (FHE) allows taxpayers to increase their income exclusion amount based on housing expenses paid throughout the year.

The purpose of this is to . . . 

The Baseline Rule

To be eligible to claim a foreign earned income exclusion, a taxpayer must meet the following conditions:

1. The taxpayer must qualify for, and claim, the Foreign Earned Income Exclusion;
2. The taxpayer must have “qualified foreign housing expenses”;
3. The taxpayer must have paid for those housing expenses through employer provided funds (kind of);
4. The housing expenses must exceed the base amount specified based on the location in which the expenses are incurred.

The 3rd part of the above rule requires that a taxpayer pay for their housing expenses with employer provided funds. Obviously, if a taxpayer is self-employed, she would not meet this rule. However, this is an exception to this rule for those making over the FEIE amount ($112,000 in 2022), so continue reading if that’s applicable to you. I'll break down each of these four requirements.

1. FEIE

The taxpayer must qualify for, and claim, the Foreign Earned Income Exclusion

For this rule, see the FEIE above blog post.

2. "Qualified foreign housing expenses.”

Qualified foreign housing expenses include rent, utilities (except for telephone, TV, and internet), parking fees, leasing fees, repairs costs, and furniture.

3. Employer Provided Funds

For purposes of this requirement, employer provided funds are any amounts paid to you by your employer where that amount is also included in your gross income. Unless the employer pays the expenses directly, AND the employee is not required to lump the value of those paid expenses into their income, the amounts paid towards expenses should be part of gross income.

Although this rule seems pretty black and white, there is a big exception. This exception only applies to those with income over the FEIE exclusion amount ($112,000 in 2022). The tax code has a provision allowing “special rules where housing expenses not provided by employer.” Self-employed individuals may deduct the lesser of their qualified housing expenses (as calculated in part C below) or their amount of foreign earned income in excess of the excludable amount. I know that is confusing. Allow me to illustrate with an example.

Assume, taxpayer has $154,100 of foreign earned income. In 2018, the FEIE limit is $104,100. Therefore, $50,000 of taxpayer’s income is not excludable. Assume also that taxpayer has $40,000 in qualified housing costs. Hypothetically, only $25,000 of that $40,000 is an excludable housing costs due to the calculations discussed below. Taxpayer has $25,000 of deductible housing costs and $50,000 of non-excludible income. The tax code allows taxpayer a deduction equal to the smaller of those two numbers. Here, that would be the $24,000. Note, that I’m underlining “deduction” here because this amount is a deduction and not an income exclusion like the FEIE.

In this example, taxpayer has an exclusion of $104,100 and a deduction of $24,000.

Let’s change up the example some and make taxpayer’s income $114,100. Now, the non-excluded amount of income is only $10,000. $10,000 is less than the $24,000 of housing costs, so the $10,000 is the deductible amount.

I noted above that this exception only applies to those making above the exclusion amount. That’s because where a taxpayer’s income is less than the exclusion amount, can be no amount over that threshold to consider. The amount “over the exclusion amount” is $0. The lesser of $0 and housing costs is always going to be the housing costs.  

4. Location Based Amounts

This bit is rather complicated and is calculated in the steps below under “Amount to be excluded.”

A Second Example

Here, let’s assume the following facts for a taxpayer named Phil. Phil paid $20,000 during the year for qualifying expenses, and his foreign earned income was $60,000. The following chart reflects his days spent abroad.

The above chart also reflects steps 1-3.

STEP 4: $33,872.95

STEP 5: $20,000

STEP 6: $20,000

STEP 7: $4,826.36

STEP 8: 93%

STEP 9: $96,813

STEP 10: $60,000

STEP 11: $0

STEP: 12 $0

The outcome is that Phil gets no foreign housing deduction.

Assume instead that Phil’s foreign earned income was $115,000. Everything would remain the same up until Step 11.

STEP 11: $18,187

STEP 12: $18,187

In this outcome, Phil makes above the max FEIE. Therefore, he gets a housing deduction of $18,187.

The Key Takeaways

If you did not follow all the rules and math in this section, the takeaways are this

• If you either (1) have an employer and you incur out-of-pocket living expense costs or (2) are self-employed making over the exclusion amount ($104,100 in 2018 adjusted for inflation thereafter) you most likely can take either an exemption or a deduction for some of your living expenses. 
• The exemption/deduction amount is tied to the city or cities in which you resided based on expected cost of living in that city. Therefore, you can’t cheat the system by renting mansion in a less expensive country
• The FEIE and Housing Exemption and Deduction are very complex. If you think you could benefit, hire a tax preparer with expertise on these issues.

Quick Links to Each Part of this Blog Series

Part I

Part II

Part III 

Part IV 

Part V