This article applies to U.S. citizens whose tax home is in a foreign country and elects to apply the U.S. tax code’s housing cost exclusion.
Abstract: The IRS recently provided 2021 adjustments to the limitation on housing expenses under the U.S. tax code’s housing cost exclusion for specific locations. The agency also noted that some taxpayers may elect to apply the 2021 limitation for tax years beginning in 2020. This article explores the key details.
In Notice 2021-18, the IRS recently provided 2021 adjustments to the limitation on housing expenses under the U.S. tax code’s housing cost exclusion for specific locations. The guidance further provides that some taxpayers may elect to apply the 2021 limitation for tax years beginning in 2020. Let’s look at some key details.
How the Math Works
The tax code allows a qualified individual to elect to exclude from gross income their foreign earned income and housing cost amount. Generally, a qualified individual is a U.S. citizen whose tax home is in a foreign country. The “housing cost amount” is generally the total of the housing expenses for the tax year minus a base housing amount.
The base housing amount is 16% of the maximum foreign earned income exclusion amount ($108,700 for 2021) multiplied by the number of days the taxpayer lived abroad during the qualified individual’s tax year. Assuming the qualified individual lives abroad the entire tax year, the base housing amount for 2021 is $17,392 ($108,700 x 16%).
The limit on excludible housing expenses generally equals 30% of the maximum foreign earned income exclusion amount multiplied by the number of days the taxpayer is a qualified individual. Thus, under this general limitation, a qualified individual who lives abroad an entire tax year is limited to housing expenses of $32,610 ($108,700 x 30%) for 2021.
The IRS is authorized to issue regs or other guidance to adjust the limitation based on geographic differences in housing costs relative to housing costs in the United States. Using its authority under the tax code, the tax agency publishes annual notices adjusting the limitation on housing cost amounts for certain high-cost areas.
In Notice 2021-18, the IRS announced an increase to the maximum allowable housing expense limitation above the otherwise applicable limitation of $32,610 for the following localities:
Angola, Argentina, Australia, Austria, the Bahamas, Bahrain, Barbados, Belgium, Bermuda, Brazil, Canada, Cayman Islands, Chile, China, Colombia, Costa Rica, Democratic Republic of the Congo, Denmark, Dominican Republic, Ecuador, Estonia, France, Germany, Ghana, Greece, Guatemala, Guinea, Guyana, the Holy See, India, Indonesia, Ireland, Israel, Italy, Jamaica, Japan, Kazakhstan, Korea, Kuwait, Luxembourg, Macedonia, Malaysia, Malta, Mexico, Mozambique, the Netherlands, Netherlands Antilles, New Zealand, Nigeria, Norway, Oman, Panama, Peru, Philippines, Poland, Portugal, Qatar, Romania, Russia, Saudi Arabia, Singapore, Slovenia, South Africa, Spain, Suriname, Switzerland, Taiwan, Tanzania, Thailand, Trinidad and Tobago, Ukraine, United Arab Emirates, United Kingdom, Venezuela and Vietnam.
Hungary, which was on the list in 2020, isn’t on the list for 2021.
Example: Say a U.S. taxpayer works in Hong Kong, China, for all of 2021. The annual limitation for Hong Kong is $114,300. The taxpayer’s maximum housing cost exclusion is $96,908 ($114,300 annual limit on housing expenses in Hong Kong per Notice 2021-18, minus the $17,392 base amount).
For some locations, the limitation on housing expenses provided in Notice 2021-18 may be higher than the limitation on housing expenses provided in Notice 2020-13 for 2020. A qualified individual incurring housing expenses in one of these locations during 2020 may elect to apply the adjusted limitation on housing expenses provided in Notice 2021-18 in lieu of the amounts provided in Notice 2020-13 (and as set out in the instructions for Form 2555, “Foreign Earned Income”).
The IRS anticipates that future annual notices providing adjustments to housing expense limits will offer a similar election to qualified individuals that incur housing expenses in the immediately preceding year. For instance, when adjusted housing expense limitations for 2022 are issued, taxpayers will likely be permitted to apply those adjusted limitations to the 2021 tax year. Contact your tax advisor for further information.
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