by Jane A. Bruno

What Is It and Can It Work for You?

    Most Americans that live and work overseas are familiar with the foreign earned income exclusion that allows up to $70,000 of foreign income to be excluded from U.S. tax every year. (Please keep in mind that this amount will go up starting in 1998 by $2,000 a year until it reaches $80,000.) However, you may be unfamiliar with the foreign housing exclusion.

This exclusion can be used to shelter amounts over and above the $70,000 from U.S. tax. The problem is figuring out if you’re allowed to take this exclusion and how it works. Hopefully, by the time you finish this article, you will have some insight into the whole process and whether it applies to you.

General Application of Foreign Housing Exclusion

     The underlying theory of the foreign housing exclusion is that you willget a tax break if your housing expenses overseas exceed a certain number that is considered an "average" housing cost in the U.S. However, it is important to note at the outset that the foreign housing exclusion only applies if you are an "employee". If you are considered "self-employed", you must use the foreign housing deduction (this will be the topic of another article). Also, the foreign housing exclusion only comes into play if you make in excess of $70,000, and you are trying to shelter some of that excess from U.S. tax.

Housing Expenses that Can Be Included

     Your first job is to figure out the total amount of housing expense that can qualify for the exclusion. In general terms, you can exclude "reasonable" housing expenses such as rent (or the fair rental value of housing if your employer provides it), utilities, repairs, real and personal property taxes, rental of furniture, fees for residential parking, etc. You cannot include deductible interest or taxes, or other costs to buy property, the cost of domestic help or telephone charges, and a variety of other expenses.

Compare Housing Expenses to "Base Amount" to Get "Housing Amount"

      Once you have determined your housing expenses, you have to take that number and subtract from it the "base amount". The base amount is 16% of the annual salary of a GS-14, step 1, U.S. Government employee. For 1996, that amount was $9,242 for the year or $25.25 per day. While one has to wonder how this particular formula was chosen, it is easier to think of it terms of being an "average" housing cost in the U.S. To the extent your housing costs exceed that number, you may get a tax benefit. Thus, for example, if you had qualified housing costs of $13,500, you would subtract from that the base amount of $9,242. The result, $4,258, is your "housing amount".

Calculating the "Foreign Housing Exclusion"

     Once you have the housing amount, you need to find one more number, the "employer -provided amount". In general, this is your salary, but it also includes any other amounts paid on your behalf by your employer, such as amounts paid to educate your children, amounts paid for housing, etc. If your housing amount is less than your employer-provided amount, you can take the entire housing amount as your foreign housing exclusion. This will be added to your foreign earned income exclusion to increase the total amount that is excludible from U.S. tax.

      Thus, for example, if your foreign earned income was $80,000, you can only exclude $70,000 from U.S. tax using the foreign earned income exclusion. However, if you had a housing amount of $4,258 (as calculated above), you could combine that with your earned income exclusion so that you could exclude from U.S. tax a total of $74,258. This can represent a significant tax savings, and require very little effort on your part to calculate.

Jane A. Bruno is an attorney with a Master's in Tax Law from George Washington University. She has extensive experience with tax issues related to living overseas, having lived in several countries in Europe and Africa over the past 12 years. A former IRS employee, she has worked as a tax consultant/preparer in such diverse places as Germany, South Africa and the Commonwealth of Virgina. She recently published:

The Expat's Guide to U.S. Taxes (Hands on Help for Americans Overseas)
by Jane A. Bruno

This self-help book presents in simple and concise form the complicated U.S. tax laws that impact on Americans living overseas. It covers a wide range of topics, starting with the most common tax situations for Americans living overseas and ending with an appendix of tax forms and other important tax information. Numerous examples are used to clarify difficult points and tax saving tips are given where appropriate.