The Internal Revenue Service has released Notice 2007-77 that provides guidance on the adjustments to the foreign housing expense limitation for certain foreign locations on the basis of differences in housing costs in relation to the United States. The limitation for an individual residing in Bermuda for 2007 is $72,000, the same as it was in 2006.

 

 

There continues to be confusion as to what the $72,000 represents. Many U.S. citizens residing abroad believe (falsely) that it is the maximum foreign housing exclusion that they can claim. This is an erroneous assumption.

 

The underlying philosophy is that the Internal Revenue Service is allowing an individual to claim a housing exclusion to the extent that the foreign housing cost exceeds what the individual would have paid in the United States. Given this philosophy, the Internal Revenue service was given the task of designing a single formula that would be fair to 350,000 individuals.

 

The maximum foreign housing exclusion that an individual can claim is calculated using a two part formula. The basic formula is tied to the amount of the foreign earned income exclusion which is $85,700 for 2007. The Internal Revenue Service somehow divined that the average American living outside the United States would spend 30% of the $85,700 exclusion or $25,710 for foreign housing in 2007. The Internal Revenue Service also divined that if the individual were living in the United States that they would spend 16% of the $85,700 exclusion or $13,712 for housing in the United States. This resulted in the Internal revenue Service computing that the cost of foreign housing ($25,710) exceed the cost of housing in the United States ($13,712) by $11,998 making the maximum foreign housing exclusion $11,998.

 

After receiving thousands of irate calls, letters and emails, the Internal Revenue Service faced reality and recognized that their precise formula did not fit all global locations. This has resulted in the Internal Revenue Service publishing a list of exceptions to the upper limit of 30% of the $85,700 exclusion or $25,710 for foreign housing in 2007. The current list consists of major cities in 58 countries and assigns a substitute upper limit in lieu of the $25,710 for individuals residing in these cities or countries.

 

For Bermuda the 2007 limit is $72,000. To determine your foreign housing exclusion, you need to deduct $13,712 from this amount, so your maximum foreign housing exclusion for 2007 will be $58,288.

 

One other caveat. To use the $72,000 amount you have to actually incur $72,000 in foreign housing costs. Foreign housing costs include rent, utilities (except for telephone), homeowners insurance, repairs, occupancy taxes, residential parking, and rental of furniture and accessories. So if you only spend $50,000 in 2007, your maximum foreign housing exclusion for 2007 will be $36,288 ($50,000 less $13,712).

 

 

The tax law change that took place in June 2006 significantly changed the tax benefit of being able to claim the foreign earned income and housing exclusions when it changed the exclusions from your highest bracket to your lowest bracket. In 2007 the maximum exclusion that can be claimed is $85,700 and $58,288 or $143,988 in total.

 

If you are married and file a joint tax return your 2007 tax benefit from claming the exclusions will be $29,309. If you filing as single your 2007 tax benefit from claming the exclusions will be $34,427.

 

Under the old law the maximum tax benefit for both married filing joint and single would have been $50,396.

 

 

If you sell your principal residence, and have owned and lived in it for 2 of the 5 years prior to sale, you can exclude $500,000 of the gain from income tax. The remainder of the gain, if any, is taxed at capital gain rates. But Congress is about to close a loop hole in the law.

 

Suppose you live in Boston and have a vacation home on Cape Cod that you use for a month each summer and rent out the remainder of the year. As you are ready to move to Florida for retirement, your tax advisor would likely tell you to sell the Boston property and claim the $500,000 exclusion, and then move to the Cape Cod property, making it your new principal residence, stay there for 2 years, sell it, claim another $500,000 exclusion, and then move to Florida. Perfectly legal tax planning under the law.

 

The House has now passed a bill that will require you to live in the Cape Cod house for 5 years before you can sell and claim another $500,000 exclusion. It is expected that the Senate will pass this bill later this year.

 

 

If you do not want to live in Cape Cod for 5 years and do not want to pay tax on the gain on the sale of the Cape Cod property, you might consider researching as to whether the property qualifies for a like kind exchange. You would first have to find a property in Florida that you would like to buy. Then, you would ask the potential buyer of your Cape Cod property to actually buy the Florida property, and then trade it to you for your Cape Cod property. If you meet all the legal aspects of the like kind exchange rules, there is no tax on the trade and you basis in your Florida property is the same as it was in your Cape Cod property.

 

Like kind exchanges are becoming so common in seaside resorts, that business have been founded who do nothing but act as facilitators for like kind exchanges.