The Internal Revenue Service (IRS) just issued Notice 2021-18. This is the geographical list that spells out adjustments to the foreign housing exclusion available for many US persons living abroad. These limitations are made on the basis of geographic differences in housing costs relative to housing costs in the United States. The ability to deduct or to exclude certain amounts provided by an employer for housing is something a taxpayer living and working Stateside cannot generally do. Housing costs are “personal” in nature and the tax laws do not provide exclusions or deductions for personal expenditures. Special rules exist that change this result for eligible individuals who work abroad on the premise that Congress did not wish to discourage Americans from moving overseas where housing might be more expensive than if the individual was living in the USA.
A foreign housing exclusion is available for certain overseas housing expenses that exceed a “base housing amount”. Self-employed persons cannot claim the foreign housing exclusion. Self-employed taxpayers living abroad must claim the foreign housing deduction instead. (See Publication 54, specifically, the section on the foreign housing deduction.)
Generally, the allowable housing expenses that one can exclude (or deduct, if self-employed) are the reasonable expenses (such as rent, utilities other than telephone charges, and real and personal property insurance) paid or incurred during the year by the taxpayer, or on his behalf, for foreign housing. The housing costs include those of the spouse and dependents if they lived with the taxpayer. Allowable housing expenses do not include the cost of a home purchase or other capital items, wages of domestic servants, or deductible interest and taxes. My blog post here explains possible workarounds for mortgage interest and foreign real property taxes in light of tax law changes brought about in 2017 by the “Tax Cuts and Job Act” – it’s a must-read for those paying such amounts.
- Some taxpayers mistakenly believe if they use only a portion of the employer-provided housing amount, they can still exclude the full amount permitted under the foreign housing exclusion rules. This is not so. The taxpayer must actually incur the claimed amounts in rental payments.
- In many cases, a taxpayer will purchase and own his own home in a foreign country, and will not pay rent. The foreign housing exclusion or deduction cannot be claimed in this instance. This comes as a surprise to many taxpayers. To be eligible, the taxpayer must actually incur the amounts in allowable housing expenses (for example, rent paid to the landlord on the employee’s behalf by the employer or paid by the taxpayer to the landlord from his employer-provided housing amount).
- If both spouses work and both receive housing amounts from their employer, only one housing exclusion can be claimed.
All numbers used in the post are in USD. To be eligible for exclusion from tax (or deduction), the allowable housing expenses must exceed a so-called “base housing amount”. The base housing amount represents an amount that a taxpayer would be assumed to pay if he was living in the US – thus, it is not eligible for exclusion/deduction since it is viewed as a “personal” expenditure (everyone has to live someplace!).
The base housing amount is 16 % of the maximum Foreign Earned Income Exclusion amount (FEIE). For 2021, assuming the taxpayer qualifies for the entire calendar year, this “base housing amount” is $17,392 (computed as follows: 16% x $108,700, which is the 2021 FEIE amount). 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 foreign earned income exclusion. For 2021 30% of the FEIE is $32,610; computed by taking 30% of $108,700. Therefore, for 2021 many taxpayers may only exclude from income the difference between the $32,610 limitation and the $17,392 base housing amount, or $15,218. This number will be higher for Americans employed and living in high-rent cities as determined by the IRS. For example, as relevant to many of my readers, Dubai and Abu Dhabi in the United Arab Emirates are included on the list of cities where housing costs are greater. Further details are discussed below.
2021 Geographic Housing Cost Allowances
The IRS was given authority to issue regulations or other guidance providing for the adjustment of this 30 percent maximum ceiling limitation based on geographic differences in housing costs relative to housing costs in the United States. In 2021, for those in Dubai, the IRS granted an adjustment of this 30 percent maximum ceiling limitation and increased it to a maximum of $57,174. For those living in Abu Dhabi, the maximum ceiling is $49,687. These ceiling limitations have not changed over the past several years (e.g., See IRS Notice 2016-21 and IRS Notice 2013-31).
United Arab Emirates – Dubai & Abu Dhabi
Using the newly announced numbers, an employee paying rent in Dubai can exclude from income the difference between the IRS announced limitation for Dubai (for 2021 this number is $57,174) and the $17,392 “base housing amount”. Since the FEIE has risen, the “base housing amount” (which is the amount on which tax must be paid) has likewise increased. This means that less employer-provided housing amounts can be excluded than in earlier years.
Using these figures, for 2021, an employee residing in Dubai can exclude only $39,782 (assuming he pays such amounts in rent etc.). By comparison to 2016 an employee residing in Dubai could exclude $40,966 of employer provided housing amounts from income provided that the amounts were actually used for that purpose; and that same employee could have excluded $41,558 in 2013. For an employee living in Abu Dhabi in 2021, he can exclude $32,295 of employer provided housing amounts, computed by subtracting the $17,392 “base housing amount” from the ceiling of $49,687. By comparison to 2013, that same employee could have excluded $34,071.
Are the 2021 Numbers Better for Your 2020 Tax Return?
The Notice specifies that if the limitation on housing expenses is higher for taxable year 2021 than the adjusted limitations on housing expenses provided in Notice 2020-13 (relating to the 2020 tax year), qualified taxpayers may apply the adjusted limitations for taxable year 2021 to their 2020 tax returns. For those in Dubai and Abu Dhabi, this will not make a difference as the ceiling limitation amounts have not changed from 2020 to 2021. However, taxpayers in other cities should check if the 2021 ceiling number is higher when compared to the 2020 number, and if so, then they can use that higher ceiling on the 2020 tax return. A very cursory glance at comparisons between the two IRS Notices for many major cities indicates that the 2021 ceiling amounts have in fact dropped rather than gone higher, so this beneficent gesture from the IRS may not be helpful to many individuals.
Tax Return Must be Filed Or Benefits Can Be Lost
All taxpayers must remember that the exclusion benefits can be claimed only if a federal tax return is filed within certain time deadlines. Many Americans incorrectly think they do not need to file returns if their income is below the exclusion thresholds. They risk losing the benefits completely.
If you have not filed tax returns, don’t miss out. We can help you catch up on the filings and claim the exclusions – probably penalty-free. Email me at email@example.com to arrange a consultation.
Posted March 4 2021
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