Overseas Americans are entitled to certain tax breaks assuming various qualifications are met. One of the significant tax breaks is the ability to exclude from taxable income certain amounts provided by an employer for foreign housing.
Housing costs are “personal” in nature and the tax laws do not provide exclusions or deductions for personal expenditures. A special tax law changes this result for those who work overseas since Congress did not want to discourage Americans from moving abroad where housing might be more expensive. Unfortunately, the permissible housing exclusion in high-rent cities has not kept pace with inflation because IRS housing “ceiling” amounts have remained static for over a decade.
FHE: The Basics
The foreign housing exclusion allows U.S. expats to exclude from income certain reasonable overseas housing expenses if they are (i) eligible (ii) exceed a base housing amount and (iii) do not exceed a specified ceiling amount.
While the FHE is not available for self-employed individuals (since an employer is not paying housing costs for them), they can deduct the eligible foreign housing amounts from taxable income.
Eligible Housing Expenses
Eligible housing expenses include reasonable housing costs for the taxpayer, his spouse and dependents if they reside with the taxpayer abroad. Included are rent, utilities (except for telephone charges), real or personal property insurance and costs for furniture rental. These costs must actually be paid or incurred during the year by the taxpayer and reimbursed or paid by the employer on the taxpayer’s behalf.
Certain costs are not eligible, including home purchase costs or capital expenses, domestic servant wages, costs to purchase furniture, mortgage interest and property taxes. A possible workaround may exist for mortgage interest and foreign real property taxes in light of restrictions imposed by the Tax Cuts and Jobs Act of 2017.
Common Mistakes To Avoid
Common errors arise when interpreting the parameters of the FHE:
· Some taxpayers believe they can exclude the full amount of an employer-provided housing allowance, even if they do not spend the entire amount. This is incorrect—only actual qualifying expenses (e.g., rent paid) are eligible.
· Expats who own a home abroad and receive housing amounts from their employers often assume they can still claim the exclusion even if they are not paying rent. Home ownership does not qualify. As mentioned though, mortgage interest or foreign real property taxes may possibly be eligible.
· If both spouses work abroad and receive housing allowances, only one may claim the foreign housing exclusion.
Calculating the FHE
The IRS only allows exclusions or deductions for eligible housing expenses that exceed a “base housing amount”. The base housing amount is generally the amount the IRS assumes a taxpayer would pay for housing if they were living in the U.S. and which is considered an ineligible personal expense.
The amount is set at 16 percent of the current year’s foreign earned income exclusion amount. For 2024, the FEIE is $126,500, so the base housing amount for 2024 is $20,240 (16% x $126,500). Reasonable foreign housing expenses in excess of the base housing amount are eligible for the exclusion, but such expenses are subject to a maximum ceiling which is generally 30 percent of the taxpayer’s FEIE (for 2024, the maximum ceiling is $37,950, calculated as 30% x $126,500).
The permitted FHE amount is the difference between the standard maximum ceiling and the base housing amount: $37,950 – $20,240 = $17,710.
IRS Higher Ceiling Amounts For High-Rent Cities Have Stagnated
For many expats, $17,710 is the maximum housing exclusion or deduction they can claim in 2024 unless living in an IRS-designated high-cost location. The IRS annually provides higher ceiling allowances for housing in foreign cities with elevated costs, such as Geneva, Tokyo, Dubai and many others.
Outdated IRS Housing Allowances In High-Cost Cities
The IRS has not updated its geographic-specific high-cost housing allowances in many years, and they no longer keep pace with rising rents and inflation. Although the FEIE increases annually, so does the base housing amount (calculated as 16% of the FEIE). If the IRS housing ceilings remain static, the result is less employer-provided housing that can be excluded from income.
Example: Impact on an Expat in Dubai
In 2023, the taxpayer lives in Dubai, where the IRS high-cost housing ceiling has been $57,174 for over a decade. With a 2023 FEIE of $120,000, the base housing amount is: 16% × $120,000 = $19,200. The taxpayer’s FHE is the difference between the ceiling ($57,174) and the base housing amount ($19,200): $57,174 – $19,200 = $37,974
Despite soaring rents, the IRS ceiling for Dubai has not changed since at least 2013. As a result, the taxpayer’s exclusion amount is shrinking year over year. Based on the relevant numbers for the calendar years chosen for this example, the expat in Dubai would have the following FHE amounts:
2023: $37,974 (calculation, above)
2021: $39,782 High-cost ceiling for Dubai minus base housing amount calculated as 16% of FEIE for 2021 of $108,700 ($57,174 – $17,392)
2016: $40,966 High-cost ceiling for Dubai minus base housing amount calculated as 16% of FEIE for 2016 of $101,300 ($57,174 – $16,208)
2013: $41,558 High-cost ceiling for Dubai minus base housing amount calculated as 16% of FEIE for 2013 of $97,600 ($57,174 – $15,616)
The static ceiling means that as rents rise and the FEIE increases, taxpayers in high-cost cities like Dubai can exclude less housing expense from income compared to earlier years. This highlights the need for the IRS to update its housing allowances to reflect current economic realities.
Why The Stagnation?
Updating the high-cost housing allowances requires resources, and with the IRS focusing more on enforcement, taxpayer compliance, and technological modernization, updates to niche allowances such as foreign housing exclusions may have taken a back seat. In some high-cost areas like Dubai or Hong Kong inflation in housing costs has risen faster than average. The IRS might be slow to adjust allowances to reflect these regional changes, as it tries to balance costs across all foreign postings.
If inflation continues without corresponding updates to the housing exclusion limits, it could reduce the financial viability of Americans working abroad. Expats could benefit from advocacy efforts to bring attention to this issue,
Thinking Ahead
Understanding the foreign housing exclusion or deduction rules is essential for those who are working abroad or planning to do so. Taxpayers living in high-cost geographic locations must especially consider the tax issues when negotiating their salary packages. More and more tax will be paid each year if the IRS does not update the high-cost geographic ceiling amounts. This is an important point that should be raised with employers.
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