The Foreign Housing Exclusion can be free money for the working Digital Nomad! Let’s find out how to qualify.
Hey there, globe-trotting digital nomads! So, you’ve swapped your cubicle for a hammock in the Philippines, Bali, or even Thailand. Did you know the Foreign Housing Exclusion availble to Digital Nomads can reduce your income by as much as $94,060?!
Trading in the 9-5 grind for sunsets on an exotic beach and conference calls from a mountaintop (with internet) is the dream for millions.
Sounds amazing, doesn’t it? But wait, before you go posting that envy-inducing Instagram story, let’s chat about something slightly less exciting but still super important: U.S. taxes.
Yep, even in paradise, Uncle Sam wants a piece of your piña colada fund. But fear not, my wanderlust-filled friend, because the Foreign Housing Exclusion (FHE) might just be your ticket to maximizing those beach bucks while staying on the right side of the IRS.
The Foreign Housing Exclusion is for employees. You get a paycheck with taxes withheld. There is a Foreign Housing Deduction which is available to those who are self-employed. Click this link for an article on the Foreign Housing Deduction.
What’s the Foreign Housing Exclusion and Why Should Digital Nomads Care?
In a nutshell, the FHE is a tax perk for U.S. expats (like yourself) allowing you to exclude certain housing expenses from your taxable income.
Sounds perfect, doesn’t it? You can travel and work abroad while potentially excluding from your income the costs of housing WHILE IN ANOTHER COUNTRY!
Think of it as the IRS throwing you a bone for braving monsoons and mastering the art of haggling in Phuket. It’s their way of saying, “We get it, living abroad can be pricey,” and it’s designed to ease the financial burden of your overseas adventure, er, employment.
Qualifying for the FHE: The Basics
Before you can qualify to exclude your housing costs, you must qualify for the Foreign Earned Income Exclusion. There is no way around it. If you don’t qualify for the FEIE, you won’t qualify for the Foreign Housing Exclusion.
Second, to snag this tax break, you’ve got to pass the bona fide residence or physical presence test, proving you’re more than just a tourist with a laptop. This means either living in your country of choice for a full tax year or being physically present there for at least 330 full days in any 12-month period. And no, visa runs don’t count towards this, so nice try.
The above is imperative. If you think of it rationally, it would be pretty tough to qualify for a FOREIGN housing exclusion if you aren’t in a foreign country.
Once you’ve got that sorted, you’ll need to show that your earnings are from bona fide work. Streaming your beach life on TikTok or Instagram might not cut it unless you’re actively treating this as a business.
This is the income to apply your Housing Exclusion against. You gotta have foreign EARNED income, people.
Calculating Your Exclusion: The Fun Part
Here’s where it gets a bit mathy, but stick with me. The IRS isn’t giving you carte blanche to write off your entire island lifestyle. There’s a limit to how much you can exclude, based on the cost of living in your Foreign locale compared to Washington D.C. (random, right?).
For 2023, the base housing amount is 16% of the Foreign Earned Income Exclusion (FEIE), which is set at $126,500, making your baseline exclusion about $20,240. This is the amount the US government has determined you would spend on your housing.
The above is a perfect example of why our politicians are so out of touch. But it is what they give us, and in this case it helps.
The second part is your locale cost. This is a table the IRS puts together outlining the limits of various areas.
Part IX shows what the IRS considers the maximum housing cost in a specific locale (or country, if small). In the example, Thailand costs $59,000 to house yourself in 2024. If you spent more than $59,000 in 2024, you are limited to that $59,000 amount.
Subtract the base amount ($20,240) from the amount on the table ($59,000) for a net amount of $38,760. You can exclude this amount on your Form 2555 (Foreign Earning Income) to exclude an additional $38,760 from being taxed.
Qualified Expenses: What Counts and What Doesn’t
Eligible expenses include rent, utilities (minus telephone charges, because apparently, the IRS thinks we’re still using landlines), real estate fees, and even the cost of leasing a Buddhist Temple if that’s your vibe. TV subscription fees are also not qualified (like Netflix or Hulu).
Additional qualified expenses are leasing fees, rental of furniture, and renters insurance. Items that don’t qualify are payments made to purchase realty (principal, interest, and escrow fees), domestic labor, or anything that can be looked at as extravagant or unnecessary.
This exclusion is specifically for your domicile in the foreign country. Your daily halo-halo fix and weekend getaways to Machu Picchu are on you. The key here is that the expenses must be reasonable (no gold-plated toilets) and directly related to your housing.
Let’s Take a look at a current example
Milicent has a lifestyle blog where she posts YouTube videos of life as a Digital Nomad in Southeast Asia.
She has decided to live in Thailand, Laos, Vietnam, and Cambodia for a year each before moving to the Philippines for good.
She fully qualified for the Foreign Earned Income Exclusion and is considered to have satisfied the Physical Presence Test by living in the same country for at least 330 days of a consecutive 12-month period. You don’t have to live in the same country for the entire period, but remember that we are talking about your DOMICILE. You won’t qualify by simply traveling around the world since you won’t have a “domicile”.
Milicent lived in Thailand for all of 2024. She had $200k or self-employment income, of which 100% was earned as an employee while in Thailand. We won’t be dealing with her Foreign Earned Income Exclusion here, just the Housing Exclusion.
Her qualified costs of housing for the year were $50,000.
Milicent can exclude $29,760 from being taxed ($50,000 – 20,240 = $29,760). You are still responsible for your self-employment taxes.
Getting It Right: Tips and Tricks
This is an area the IRS will scrutinize. For this reason, I would advise you to go a little nuts with your record-keeping. Track everything and keep receipts.
1. Keep Impeccable Records: The IRS loves paperwork more than you love sunset selfies. Keep every receipt, lease agreement, and utility bill. If it proves you paid for housing, save it. If your bank account is with a local bank, save the statements. The same goes for credit card statements.
2. Understand the Local Cap: Each location has its cap based on the cost of living. Manila might have a higher cap than a remote beach town. Know your limits to maximize your exclusion.
IMPORTANT: This is also important if your cost of living is LESS than the base established by the IRS (the 16% amount). If you don’t have $20,240 in qualified foreign housing expenses, you won’t have a Foreign Housing Exclusion.
3. Professional Help is Key: You know me. I’m not dismissing anyone’s mental capacity, but it would be really easy to make a mistake on this. If you make a mistake in one year, chances are the mistake will be on multiple years’ returns. With an issue with a higher audit risk (such as the Foreign Earned Income Exclusion and the Foreign Housing Exclusion), I will always advise you to seek professional help.
4. Timing is Everything: The timing of your expenses and income matters. Planning and smart financial management can help you leverage the FHE more effectively.
Milicent made the decision to live in 5 different countries over a 5 year period. She was planning FOR the FEIE and FHE. She made sure to qualify for both each year knowing she could save thousands in taxes by planning properly so she could benefit from the FEIE, and by extension, the Foreign Housing Exclusion..
5. Tax laws tend to change, or be “adjusted” annually. What’s accurate now might be outdated by your next visa extension. Keep up to date or have someone do it for you.
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Conclusion – Living the Dream Without the Tax Nightmare
So, there you have it, my wandering friends. With a bit of specific planning and a keen eye on your expenses, the Foreign Housing Exclusion can help make your digital nomad dream a bit sweeter (and more affordable). Remember, it’s not just about finding the perfect beach or mastering the art of remote work; it’s also about smart tax planning to ensure your adventure continues as smoothly as possible.
And let’s be real, nothing says “successful digital nomad” like sipping a coconut on the beach, confident in the knowledge that you’ve got your tax situation locked down tighter than your Instagram game. So, go ahead, and enjoy that sunset. You’ve earned it – both the view and the tax savings. Cheers to living your best life, wherever in the world that may be!
And with the tax savings, you can start your own Solo 401k, save for retirement, AND save even MORE on taxes!
There you have it folks. Stay cool and talk later.
JKC