Living abroad as a self-employed U.S. expat comes with unique financial benefits, one of which is the Foreign Housing Deduction. This deduction can significantly lower your taxable income by allowing you to deduct certain housing costs from your earnings. This guide will provide a clear and concise understanding of how the Foreign Housing Deduction works, who qualifies, and how to maximize your tax savings.
WHAT IS THE FOREIGN HOUSING DEDUCTION?
The Foreign Housing Deduction allows self-employed expats to deduct foreign housing expenses from their gross income. Unlike the Foreign Housing Exclusion, which applies to employer-provided amounts, the deduction is specifically for those with self-employment income. This can help reduce your tax liability and make living abroad more affordable.
WHO QUALIFIES?
To qualify for the Foreign Housing Deduction, you must:
Have self-employment income.
Have a tax home in a foreign country.
Pass either the bona fide residence test or the physical presence test for an uninterrupted period that includes an entire tax year.
Bona Fide Residence Test: You must be a bona fide resident of a foreign country for an uninterrupted period that includes an entire tax year. This means you must establish a residence in the foreign country and intend to live there for a substantial period.
Physical Presence Test: You must be physically present in a foreign country or countries for at least 330 full days during any 12-month period. This test is based solely on your physical presence, regardless of the nature of your stay or your intentions.
The foreign housing deduction only applies to amounts paid for with self-employment earnings. It does not reduce your self-employment tax liability. Your housing expenses must exceed 16% of the FEIE amount for the given tax year. For 2024, the base housing amount is $20,240 (16% of $126,500).
The deduction is limited to 30% of the FEIE amount, which is $37,950 for 2024. However, if you live in a high-cost area, your limit may be higher. To calculate the deduction, subtract the base housing amount from your eligible housing expenses. Any unused amount can be carried over to the next year, but cannot be carried over beyond that.
WHAT COUNTS AS FOREIGN HOUSING EXPENSES?
Qualified housing expenses include reasonable costs incurred for housing in a foreign country for you and your family. These expenses must be necessary for living abroad and include:
Rent
Utilities (excluding telephone charges)
Property insurance
Fees for securing a lease
Rental of furniture
Repairs
Residential parking
Certain expenses do not qualify, such as:
Lavish or extravagant expenses
Mortgage interest or property taxes
The cost of buying property
Domestic labor (maids, gardeners)
Improvements that increase property value
HOW TO CALCULATE THE FOREIGN HOUSING DEDUCTION?
Determine Your Total Housing Expenses: Add up all your eligible foreign housing expenses for the year. These include costs such as rent, utilities, property insurance, and repairs. Only the portion of these expenses incurred while living in a foreign country is eligible.
Subtract the Base Housing Amount: The base housing amount is 16% of the maximum foreign earned income exclusion (FEIE). For 2023, the FEIE is $120,000, making the base housing amount $19,200 annually or $56.60 per day. This amount represents a standard threshold of housing expenses that the IRS assumes any taxpayer will incur.
Calculate the Deduction: Subtract the base housing amount from your total housing expenses. The remaining amount is your potential housing deduction, subject to limits.
Apply the General Limitation: Your housing deduction cannot exceed your foreign earned income minus the total of your foreign earned income exclusion and any housing exclusion.
Example Calculation: Suppose your total housing expenses for the year are $30,000. First, subtract the base housing amount of $19,200, resulting in a housing amount of $10,800. If all your income is from self-employment, you can deduct this $10,800 on line 24j of Schedule 1 (Form 1040).
SPECIAL CONSIDERATIONS FOR SELF-EMPLOYED EXPATS
Self-Employed and Employer-Provided Income: If you have both self-employment income and employer-provided amounts, you can split your housing costs accordingly. Calculate the portion of housing expenses related to employer-provided amounts and exclude that portion, then deduct the remaining amount related to self-employment.
Carryover: If your housing deduction exceeds the limit for the current year, you can carry over the excess to the next year. However, this carryover can only be used once and is subject to the same limits in the carryover year.
Additional Child Tax Credit: You cannot claim the additional child tax credit if you take the foreign housing deduction. Ensure you consider this when planning your tax strategy.
HOW TO CLAIM THE FOREIGN HOUSING DEDUCTION?
To claim the Foreign Housing Deduction, include it on line 24j of Schedule 1 (Form 1040) when you file your U.S. tax return. Detailed information about your income, housing expenses, and residency status will be required. Make sure to gather all necessary documentation to support your claim, including receipts and lease agreements.
IMPORTANT NOTES
Double Benefits Not Allowed: You cannot include expenses for housing that you have already excluded from gross income, such as employer-provided lodging. This prevents double-dipping into multiple tax benefits for the same expense.
Foreign Tax Credit or Deduction: Once you choose to deduct foreign housing amounts, you cannot take a foreign tax credit or deduction for taxes on income you can exclude. This is to ensure that taxpayers do not receive multiple tax benefits for the same income.
Joint Tax Returns and Separate Claims: If both you and your spouse are self-employed and meet the qualifications, you can both claim the housing deduction. However, if you file separate returns, each spouse must calculate their deduction separately based on their respective housing expenses and foreign earned income.
MAXIMIZING YOUR TAX BENEFITS
The Foreign Housing Deduction is a valuable tool for self-employed expats to reduce their taxable income. Here are some tips to maximize your tax benefits:
Keep Detailed Records: Maintain thorough records of all housing expenses, including receipts, lease agreements, and utility bills. This documentation is crucial for supporting your deduction claim.
Plan for High-Cost Localities: If you live in a high-cost locality, check the IRS list for specific limits on housing expenses. This can help you maximize your deduction by allowing you to claim more than the standard limit.
Monitor Your Qualifying Period: Ensure you meet the physical presence or bona fide residence test for the entire tax year to qualify for the deduction. This requires careful planning and tracking of your time spent abroad.
Consult a Tax Professional: Consider consulting with a tax professional who specializes in expat taxes. They can provide personalized advice and help you navigate the complexities of the Foreign Housing Deduction.
UNDERSTANDING THE IMPACT ON YOUR TAX LIABILITY
By effectively utilizing the Foreign Housing Deduction, you can significantly reduce your taxable income and lower your overall tax liability. This deduction, along with the foreign earned income exclusion, helps reduce the tax burden on income earned abroad, making living overseas more financially viable.
For personalized advice, contact 1040 Abroad for free tax advice via email from our Enrolled Agents. This guide aims to simplify the process and help you make the most of your expat tax benefits. By leveraging these benefits, self-employed individuals living abroad can effectively manage their tax liability and enjoy the many financial advantages of living and working in a foreign country.
Have a question? Contact Olivier Wagner, 1040 Abroad
