The Tax Increase Prevention and Reconciliation Act of 2005 limited the amount of foreign housing exclusion that can be elected by US citizens and resident aliens living outside the United States.

The new law indicated that the Treasury Secretary could increase the upper limits of the formula where local housing costs were deemed to be higher than the limits imposed by the new law.

Recently the Treasury Department released a table prepared by the Office of Allowances of the U.S. Department of State that identifies locations within countries with high housing costs, and provides an adjusted limitation on qualified housing expenses for determining the foreign housing exclusion.

Last month we reported that the maximum foreign housing exclusion for Bermuda based expatriates was increased from $11,536 to $13,016.

In addition to Bermuda, the maximum foreign housing exclusion was increased in many countries around the world. For example, the maximum foreign housing exclusion is now $36,516 in the Bahamas, $32,416 in Brussels, $21,916 in Rio de Janeiro, $37,516 in Montreal, $52,932 in Paris, $101,116 in Hong Kong, $40,316 in Rome, $23,216 in Tokyo, $24,316 in Mexico, $14,316 in Moscow, and $21,916 in London.

The reaction of most US citizens living in Bermuda is that there is something terribly wrong with the tables. Is London housing really 50 percent more costly than Bermuda, and is housing in Hong Kong 500 percent more costly than Bermuda? Is the housing cost in Moscow equivalent to the housing cost in Bermuda? Is housing in the Bahamas twice as costly as that in Bermuda?

The answer is that the tables are based on the living quarters allowance for employees of the US Department of State who are in Group 2, with family. Simply, the housing amount shown in the table is what a State Department employee receives. It is probably a given that the tables are based in part on the fact that State department employees are not highly paid.

The Treasury has indicated that if a taxpayer believes that the table amount for Bermuda is low, that comments can be sent to Notice.commentsirscounsel.treas.gov

Exchange of Property for an Annuity Contract

Individuals have been able to either avoid or defer income tax by exchanging appreciated property for a life annuity. For example, an individual might have bought property for $250,000 that now had a fair market value of $2,000,000.

Instead of selling the property and paying tax on the gain, they would exchange it for a life annuity of $100,000 a year.

While the annuity is taxable income, they have in essence deferred paying tax on their gain as it will be paid over their lifetime.

Under what was known as the open transaction doctrine, an individual would exchange an appreciated asset that would be sold in the future for a private life annuity. When the amount to be realized was uncertain, the individual treated the initial payments from the annuity as a nontaxable return of basis.

The IRS has decided that abuse is rampant in this area and has changed the regulations to provide the exchange of appreciated property for a private life annuity is a taxable transaction and that tax must be paid on the gain in the year of the exchange.

Employer Provided Housing

Internal Revenue Code Section 119 allows an exclusion from income for the value of employer provided lodging if the employee must accept the lodging as a condition of employment, if the lodging is furnished for the convenience of the employer, and the lodging must be on the employer's business premise.

With the change in that tax law that minimises the amount of foreign housing cost that can be excluded from income, some employers are looking at whether they can reduce their tax costs by combining the housing and business premises. For example, if you are bringing a single employee to Bermuda to open a representative office that clients will not come to, if you rent a one bedroom condo in Somerset for the employee and have a small office in Hamilton, the housing allowance given to the employee must be included in income.

But if the employer rented a two bedroom condo in Hamilton with one bedroom being used as an office, it is possible that the employee may not have to include in income the value of the housing.

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The tax advice given by this column is, by necessity, general in nature. You should, of course, check with your own US tax consultant as to how specific transactions affect you since tax advice varies with individual circumstances.

James Paul Sabo, CPA, is the President of ETS Ltd., PO Box HM 1574, Hamilton HM GX, Bermuda. Questions should be sent to: jsaboexpatriatetaxservices.com