What it means
The US taxes its citizens and residents on worldwide income, which creates a heavy burden for people whose employer sends them to a costly city such as London or Hong Kong. The housing benefit recognises that rent and related costs overseas can be far above what the person would pay at home.
To qualify, the person needs a tax home in a foreign country and must pass one of two tests. The bona fide residence test looks at a full tax year of genuine residence abroad, while the physical presence test requires being outside the US for at least 330 full days in any 12-month period.
Only certain costs count. Eligible items include rent, utilities other than telephone, property insurance, parking, furniture rental and some repairs, but the purchase price of a home, mortgage principal, depreciation, and the cost of domestic help are not included.
The benefit only applies to costs above a base amount, which is a set percentage of the annual foreign earned income exclusion limit, and it is capped at another percentage of that limit. The cap can be higher in cities that the tax authority lists as high-cost locations, and the figures are updated regularly.
The distinction between exclusion and deduction matters in practice. An employee whose employer pays or reimburses housing claims the exclusion, whereas a self-employed contractor claims the deduction, which is limited by the amount of foreign earned income the person has.
The claim is made on Form 2555, which is filed with the annual tax return. It must be made on time and the person must keep records of leases, receipts and days spent abroad, because this is a regular area of review.
In practice
Real-world examples.
Example
A US engineer is posted to Singapore for two years by her employer and pays $34,000 a year in rent and utilities. She meets the physical presence test and claims the housing exclusion on her return.
Example
A self-employed American designer lives in Lisbon and works for clients worldwide. She claims the housing deduction instead of the exclusion, limited to her foreign earned income for the year.
Example
A US consultant arrives in Dubai in the middle of the year and works there until December. He prorates the base amount and the cap for the number of qualifying days, so the benefit is smaller than for a full year.
Formula
Calculation
Qualifying housing amount = lower of (eligible housing costs, cap) minus base amount
Cap = 30% of the exclusion limit and base amount = 16% of the exclusion limit, as the standard percentages
For illustration only, assume the annual foreign earned income exclusion limit is $100,000 (the official limit is set annually and differs). The base amount is 100,000 x 0.16 = $16,000 and the cap is 100,000 x 0.30 = $30,000.
Suppose an employee has eligible housing costs of $34,000 for a full year. The costs are limited to the cap of $30,000, so the qualifying amount is 30,000 - 16,000 = $14,000, which can be excluded from taxable income.Case study
Seen in the real world.
Oakridge Advisory is an illustrative, fictional US consulting firm that sent four managers to open a branch in Tokyo. Housing in the district near the office cost far more than the managers paid at home, and the firm covered part of the rent.
Two managers claimed only the foreign earned income exclusion, because they did not know about the housing benefit. When the firm's tax adviser reviewed their returns, it found that they had paid about $28,000 each in eligible housing costs, above the base amount.
In this illustrative case the managers filed amended returns to claim the housing exclusion, reducing their taxable income. The firm then added a checklist for assignees so that housing records are collected from the first month of a posting.
Watch out
Common mistakes.
- Counting the cost of buying a home or paying off a mortgage as housing expenses, when these items are specifically excluded.
- Forgetting to prorate the base amount and the cap when the person was abroad for part of the year only.
- Assuming employees and self-employed people claim the same way, when employees use an exclusion and the self-employed use a deduction.
Questions
People also ask.
Do I need to file Form 2555?
Yes, the benefit is claimed on that form, which is attached to the tax return, and it is not applied automatically.
Can I claim it if I rent my home in the US while abroad?
You may still qualify if your tax home and residence are abroad, but you must pass the residence or presence test, and the details depend on your circumstances.
Where can I find the current limits?
The tax authority publishes the exclusion limit, base amount and cap each year, along with a list of high-cost cities that have higher caps.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%Related