GLOBAL EXECUTIVE MANAGEMENT SOLUTIONS

In addition to the foreign earned income exclusion, you can also claim an exclusion or a deduction from gross income for your housing amount if your tax home is in a foreign country and you qualify for the exclusions and deduction under either the bona fide residence test or the physical presence test.

The housing exclusion applies only to amounts considered paid for with employer-provided amounts, which includes any amounts paid to you or paid or incurred on your behalf by your employer that are taxable foreign earned income to you for the year (without regard to the foreign earned income exclusion). The housing deduction applies only to amounts paid for with self-employment earnings.

Your housing amount is the total of your housing expenses for the year minus the base housing amount. The computation of the base housing amount (line 32 of Form 2555) is tied to the maximum foreign earned income exclusion. The amount is 16% of the maximum exclusion amount (computed on a daily basis), multiplied by the number of days in your qualifying period that fall within your tax year.

Housing expenses include your reasonable expenses actually paid or incurred for housing in a foreign country for you and (if they lived with you) for your spouse and dependents. Consider only housing expenses for the part of the year that you qualify for the foreign earned income exclusion. Housing expenses do not include expenses that are lavish or extravagant under the circumstances, the cost of buying property, purchased furniture or accessories, and improvements and other expenses that increase the value or appreciably prolong the life of your property. You also cannot include in housing expenses the value of meals or lodging that you exclude from gross income (under the rules for the exclusion of meals and lodging), or that you deduct as moving expenses.

Also, for purposes of determining the foreign housing exclusion or deduction, your housing expenses eligible to be considered in calculating the housing cost amount may not exceed a certain limit. The limit on housing expenses is generally 30% of the maximum foreign earned income exclusion, but it may vary depending upon the location in which you incur housing expenses. The limit on housing expenses is computed using the worksheet on page 3 of the Instructions for Form 2555 (PDF).

Additionally, foreign housing expenses may not exceed your total foreign earned income for the taxable year. Your foreign housing deduction cannot be more than your foreign earned income less the total of your (1) foreign earned income exclusion, plus (2) your housing exclusion.

Although the foreign housing exclusion and/or the deduction will reduce your regular income tax, they will not reduce your self-employment tax.

Your housing expenses may not exceed a certain limit. The limit on housing expenses varies depending upon the location in which you incur housing expenses. The limit on housing expenses is computed using the worksheet on page 3 of the Instructions for Form 2555 (PDF).

The foreign housing exclusion or deduction is computed in parts VI, VIII, and IX of Form 2555 (PDF). Please refer to the Instructions for Form 2555 (PDF) and chapter 4 of Publication 54.

Source: http://www.irs.gov/businesses/small/international/article/0,,id=97143,00.html