In addition to the Foreign Earned Income Exclusion (FEIE), some expats are able to deduct a portion of their housing costs via the foreign housing allowance. The intent of the foreign housing exclusion is to recognize that housing costs abroad may be higher than in the United States. To qualify, you must meet either the bona fide residence or physical presence test. The foreign housing exclusion amount is based on (1) where you live, and (2) how many days you lived outside the U.S. during the tax year.

In general, the maximum foreign housing exclusion amount is based off the FEIE. Specifically, you can deduct up to 30% of the FEIE limit ($30,630 for 2017), minus the base housing amount ($16,336 for 2017). Qualifying housing expenses include: rent, repairs, utilities (excluding telephone bills), property insurance, furniture rental and parking. Important to note, there are several hundred foreign locations for which the IRS offers a higher deduction limit. The limits for high-cost localities are listed in the instructions for Form 2555.

Foreign Housing Allowance (calculation)

1. There is a non-excludable, base amount that you must calculate. For 2017, it is 16% of the FEIE limit, or $16,336. This base amount is presumably what the IRS thinks you would be paying if living in the U.S.
2. Let’s say you are living in a foreign location where the standard 30% limit applies. Let’s assume your qualified housing expenses are $40,000. Since your expenses are above the 30% limit, the allowable expenses would be capped at the $30,630. The difference ($30,630 – the base amount of $16,336) is the amount that can be deducted.
3. If you were in the U.S. for some portion of the year, then the base amount from step 2 would be pro-rated.

Under most circumstances, expats should use the foreign housing allowance to exclude/deduct income above the FEIE limit. Same as with the FEIE, the foreign housing allowance does not decrease your self-employment tax liability.

For general information on US expat taxation, please read: US Taxes for Americans Living Abroad – Ultimate Guide.