IRC Section 933: Bona Fide Residency and Excluded Income

Under the IRC Section 933 Puerto Rico income exclusion, a bona fide resident of Puerto Rico can leave Puerto Rico-source income off their federal Form 1040, but the exclusion only applies if you meet all three IRS residency tests for the entire tax year and only to income that genuinely originates on the island. Federal government pay, Social Security, most pensions earned on the mainland, and gains on assets you owned before moving stay on your federal return. Puerto Rico still taxes the excluded income under its own system, with rates reaching 33 percent.

Who Counts as a Bona Fide Resident

You have to pass three tests, and you have to pass all of them for the full tax year. Miss one and the exclusion is gone, along with any underpayment penalties that follow.¹

Presence Test

The cleanest way to satisfy this is spending at least 183 days in Puerto Rico during the calendar year. Two alternatives work as well: spending no more than 90 days in the United States, or having no significant connection to the mainland. The IRS defines “significant connection” narrowly. You fail if you keep a permanent home in the U.S., are registered to vote anywhere in the U.S., or have a spouse or child under 18 whose principal home is stateside.¹ A permanent home means a dwelling available to you year-round, not a vacation rental. Owning a mainland property that you rent out at fair market value, with personal use of no more than 14 days or 10 percent of the rental days, generally doesn’t count against you.²

Tax Home Test

Your main place of business or employment must be in Puerto Rico all year. A secondary office on the mainland doesn’t automatically disqualify you, but if the IRS decides your primary professional activity happens elsewhere, the exclusion disappears. For freelancers and consultants, the question is where you sit while doing the work, not where your clients are.

Closer Connection Test

This one looks at your personal life as a whole. The IRS considers where your family lives, where you keep belongings, which jurisdiction issued your driver’s license, where you vote, and where your community ties are. Registering to vote in Puerto Rico, getting a local license, and moving your banking are the kinds of concrete steps that support the claim.¹

What the Exclusion Actually Covers

Section 933 excludes income “derived from sources within Puerto Rico.”³ The word that matters is “sources.” Where the income originates controls, not where it is paid or deposited.

Wages and salaries are sourced where the work is physically performed. Sit at a desk in San Juan for a New York employer, and that income is Puerto Rico-source. Independent contractor pay works the same way.

Interest qualifies when paid by Puerto Rico residents or by local financial institutions operating under island law. Dividends face a stricter two-part test: the paying corporation must derive at least 80 percent of its gross income from Puerto Rico sources during a three-year testing period, with at least 50 percent from actively conducting business on the island.⁴ Dividends from large U.S. corporations rarely meet that bar.

Income from selling personal property generally sources to the seller’s tax home, which is another reason the tax home test matters so much.

Income That Stays on Your Federal Return

Missing any of the categories below is the most common audit trigger for Section 933 filers.

U.S.-Source Income

Rental income from mainland property, dividends from U.S. corporations that flunk the sourcing test, and interest from mainland accounts all stay on Form 1040. Standard graduated federal rates apply, topping out at 37 percent for single filers earning above $640,600 in 2026.⁵

Federal Government Pay

Salaries from U.S. government agencies and the armed forces don’t qualify, even for work performed on the island. Section 933 carves this out explicitly. The rule reaches civilian military employees, federal department staff stationed in Puerto Rico, and employees of instrumentalities like post exchanges.³⁶

Social Security

Social Security payments are always U.S.-source income under IRC Section 861, so the taxable portion cannot be excluded. The same rules for figuring the taxable percentage apply as they would on the mainland.⁷

Pension Distributions

Private pensions and 401(k) distributions split into two pieces for sourcing. The portion tied to your contributions is sourced where you performed the services that earned the pension. The portion tied to investment growth is sourced where the pension trust is located. Thirty years of mainland work with a trust in Delaware means both pieces are U.S.-source, even though you now live in Puerto Rico.⁸

Gains on Assets You Owned Before Moving

This is where new residents get caught. If you owned investment property (stocks, bonds, cryptocurrency, partnership interests) before becoming a bona fide resident, gains from selling that property are generally treated as non-Puerto Rico-source for up to 10 years after your move. Treasury Regulation 1.937-2(f) calls these “tainted property,” and the rule exists to stop people from moving to Puerto Rico, immediately selling appreciated assets, and claiming the exclusion on the gain.⁹

You have an option. You can elect to split the gain between the pre-move and post-move periods, allocating the Puerto Rico-source portion based on the ratio of days you held the asset as a bona fide resident to the total days you owned it. Without that election, the entire gain defaults to U.S.-source. For assets held through a partnership, the IRS looks through the entity, so holding Bitcoin through a fund doesn’t sidestep the rule. After 10 full years of bona fide residency, the tainted designation expires and gains on those assets become Puerto Rico-source income eligible for the exclusion.

Self-Employment Tax Still Applies

Section 933 only touches federal income tax. Self-employment tax is untouched. If you earn a living as a freelancer, consultant, or business owner in Puerto Rico, you still owe the federal self-employment tax: 12.4 percent for Social Security on the first $184,500 of net earnings in 2026, plus 2.9 percent for Medicare on all net earnings with no cap.¹⁰

Report self-employment earnings on Form 1040-SS. Filing is required if your net self-employment income reaches $400, even with no other federal filing obligation.¹¹ If you expect to owe $1,000 or more in self-employment tax for the year, quarterly estimated payments are required on Form 1040-ES. Bona fide residents can also use Form 1040-SS to claim the Additional Child Tax Credit, even without any self-employment tax due.¹²

The Deduction and Credit Catch

The exclusion has a trade-off that people routinely overlook their first year. Section 933 prohibits you from claiming any deduction or credit “properly allocable to or chargeable against” the excluded income.³ You have to allocate deductions between excluded Puerto Rico income and taxable U.S.-source income using the expense allocation rules of Treasury Regulation 1.861-8.¹³

Put concretely: if 70 percent of your income is excluded Puerto Rico-source and 30 percent is taxable U.S.-source, you can generally deduct only 30 percent of expenses that aren’t directly tied to one source. The personal exemption under Section 151 is the sole carve-out; it stays fully available regardless of how much you exclude. Getting the standard deduction allocation wrong is one of the common reasons the IRS adjusts these returns.

The Excluded Income Still Gets Taxed

Excluding income from your federal return does not mean it goes untaxed. Puerto Rico runs its own income tax system with graduated rates from 0 to 33 percent on net taxable income above $61,500. Income you exclude under Section 933 is reportable and taxable by Hacienda, Puerto Rico’s Department of Treasury. For many residents earning ordinary income, the total tax burden doesn’t vanish; it shifts from federal to territorial.

Act 60 in Brief

Puerto Rico’s Incentives Code, commonly called Act 60 (a consolidation of the former Acts 20 and 22), is what drives most tax-motivated relocations. Under Act 60, qualifying Resident Individual Investors can receive a full exemption from Puerto Rico income tax on interest and dividends earned after the move, and a complete exemption on capital gains attributable to appreciation that occurs after becoming a Puerto Rico resident. Pre-move appreciation on investment assets recognized after 10 years of residency is taxed by Puerto Rico at a reduced 5 percent rate. Combined with the federal Section 933 exclusion, the total tax on investment income can be very low, but only with an approved Act 60 decree and strict compliance with the program.

Act 60 benefits are not automatic. You apply for and receive a tax decree from Puerto Rico’s Department of Economic Development and Commerce. The program has its own residency requirements, annual charitable donation obligations, and reporting conditions separate from anything the IRS asks for.

Filing and Documentation

Form 8898

When you establish or end bona fide residence in Puerto Rico, file Form 8898 if your worldwide gross income for the year exceeds $75,000. The form covers the date your status changed and details about your home, family ties, and mainland connections. Failure to file when required carries a $1,000 penalty absent reasonable cause.¹⁴

Your Federal Return

With any U.S.-source income, file Form 1040 and compute the Section 933 exclusion by subtracting qualifying Puerto Rico-source income from gross income. If all your income is Puerto Rico-source and you have no self-employment income, you generally don’t need to file a federal return at all.¹¹ Keep records that back up your exclusion: Puerto Rico returns filed with Hacienda, travel itineraries showing physical presence, utility bills, lease agreements, and bank statements.

Deadlines

Puerto Rico residents file by April 15. The automatic two-month extension available to U.S. citizens living abroad does not apply here; the IRS treats the island differently from foreign countries for this purpose.¹⁵ You can still request a six-month extension using Form 4868, but tax owed is due by April 15 regardless. Late filing runs 5 percent of unpaid tax per month or partial month, capped at 25 percent.¹⁶

Leaving Mid-Year

Section 933 ordinarily requires bona fide residency for the entire tax year. If you leave Puerto Rico mid-year after at least two consecutive years of bona fide residency, you can still exclude the Puerto Rico-source income earned in the portion of the year before departure. This partial-year rule only applies to U.S. citizens.³ Leave before the two-year mark, and you lose the exclusion entirely for that departure year and must report all income, including Puerto Rico-source income, on your federal return. The deduction disallowance rules still apply against whatever portion is excluded.

Split-Residency Couples

When one spouse qualifies as a bona fide resident and the other doesn’t, filing gets complicated. Each spouse’s residency is determined individually. If the non-resident spouse is a nonresident alien of the United States, a joint return generally isn’t available unless the couple makes a special election to treat that spouse as a U.S. resident for tax purposes.¹ The interaction between two filing statuses, the Section 933 exclusion, Puerto Rico tax obligations, and the deduction allocation rules creates real room for expensive errors, and paid help usually earns its cost.

1
Internal Revenue Service. Tax Guide for Individuals With Income From U.S. Territories
2
Internal Revenue Service. Instructions for Form 8898 – Statement for Individuals Who Begin or End Bona Fide Residence in a U.S. Territory
3
Office of the Law Revision Counsel. 26 USC 933 – Income From Sources Within Puerto Rico
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Internal Revenue Service. Income From Sources Within Puerto Rico
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Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
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Internal Revenue Service. U.S. Government Civilian Employees Stationed Abroad
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Internal Revenue Service. When Benefits Are Taxable – IRS Courseware
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Internal Revenue Service. Interest Income and Pensions
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eCFR. 26 CFR 1.937-2 – Income From Sources Within a Possession
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Social Security Administration. Contribution and Benefit Base
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Internal Revenue Service. Topic no. 901, Is a Person With Income From Sources Within Puerto Rico Required to File a U.S. Federal Income Tax Return?
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Internal Revenue Service. 2025 Instructions for Form 1040-SS
13
eCFR. 26 CFR 1.933-1 – Exclusion of Certain Income From Sources Within Puerto Rico
14
Internal Revenue Service. Residents of U.S. Territories / Possessions – Form 8898 Bona Fide Residence
15
Internal Revenue Service. U.S. Citizens and Resident Aliens Abroad – Automatic 2-Month Extension of Time to File
16
Internal Revenue Service. Failure to File Penalty