What Is IRC 933? Residency, Qualifying Income, and Form 8898

Under Internal Revenue Code Section 933, a bona fide resident of Puerto Rico can exclude income from sources within Puerto Rico from federal gross income, which means zero federal income tax on that qualifying income.¹ The exclusion is available to U.S. citizens and resident aliens alike, but it hinges on strict residency tests, careful sourcing of each dollar of income, and a set of exceptions that keep certain earnings federally taxable no matter how long you live on the island. The Puerto Rico income tax still applies to the excluded income; Section 933 shifts the tax obligation to the Commonwealth rather than erasing it.

Who Counts as a Bona Fide Resident

The exclusion is only available if you are a bona fide resident of Puerto Rico for the entire tax year. That status comes from IRC Section 937(a) and Treasury Regulation 1.937-1, and it has three parts. Miss any one for any portion of the year and the exclusion fails for that year.²

The presence test asks whether you were physically in Puerto Rico enough. The simplest way to satisfy it, and the one most people use, is spending at least 183 days on the island during the tax year. Four alternatives exist for people who travel more, including a 549-day rule that averages presence across three consecutive years (with at least 60 days in each), a rule for people who spend 90 or fewer days in the United States, a rule for those with minimal U.S. earned income, and a rule for those with no significant connections to any U.S. address.³

The tax home test requires that your tax home sit in Puerto Rico for the entire year. Your tax home is generally your main place of business or employment, not where you sleep. If you don’t have a regular place of business, it defaults to your regular place of abode. Keeping a principal office on the mainland while renting an apartment in San Juan is a common way this test fails.

The closer connection test compares your ties to Puerto Rico against your combined ties to the United States and any foreign country. The IRS weighs where your permanent home is, where your family lives, where your car and belongings are kept, where you hold a driver’s license, where you’re registered to vote, where you bank, and where you give to charity. No single factor decides it, but a furnished mainland home and a family that stayed behind cut hard against you.

What Income Actually Qualifies

Section 933 excludes only income sourced to Puerto Rico. The sourcing rules mirror the U.S.-source rules and turn on the type of income:²

Wages are sourced where you physically perform the work. Working remotely from Puerto Rico for a mainland employer is Puerto Rico-source; flying to New York for a week of meetings creates U.S.-source income for those days.
Business income is sourced where the activities generating it take place.
Interest is sourced by the payer’s residence. A Puerto Rico bank pays Puerto Rico-source interest; a mainland bank does not.
Dividends from a Puerto Rico corporation are generally territory-source.
Rental income is sourced where the property sits.
Gain from selling personal property is generally sourced to the seller’s tax home at the time of sale, subject to a major exception discussed below.
Gain from selling real property is sourced where the property is located.

One override matters more than the details: any income the normal rules classify as U.S.-source can never be reclassified as Puerto Rico-source by moving.² Dividends from a Delaware corporation, interest from a mainland bank, and rent from a New York apartment stay federally taxable whether you’ve lived in San Juan for one year or twenty.

What Still Gets Taxed by the Federal Government

Even a fully qualifying bona fide resident owes federal tax on several categories of income and one tax that isn’t income tax at all.

Federal employee pay. Compensation for services as an employee of the U.S. government or any federal agency is specifically carved out of Section 933.¹ Federal pay stays federally taxable even if the work happens entirely on the island. Active-duty military members who claim Puerto Rico as their legal residence are covered by this exception too.⁴

Mainland-source income. Anything sourced outside Puerto Rico under the rules above is reported on Form 1040 the same way as if you lived in any U.S. state.⁴ Section 933 also disallows any deduction or credit properly allocable to your excluded Puerto Rico-source income; deductions that don’t tie to a specific income item have to be allocated between excluded and taxable income, and only the taxable portion counts on your federal return.¹

Self-employment tax. Section 933 is an income tax exclusion, not a payroll tax exclusion. Net self-employment earnings of $400 or more still trigger SE tax at 15.3% on the first slice of income, funding Social Security and Medicare.⁵ Bona fide residents who don’t otherwise have to file a federal return report SE tax on Form 1040-SS with Schedule SE attached.⁶ For 2026, Social Security tax applies to the first $184,500 of combined wages and net SE earnings; Medicare has no cap, and an extra 0.9% surtax applies above $200,000 for single filers or $250,000 for joint filers.⁷ People who relocate for the income tax savings routinely miss this.

The 10-Year Lookback on Investments You Brought With You

This is the trap that catches people who move to Puerto Rico with an appreciated portfolio. If you owned marketable securities or certain other financial instruments before becoming a bona fide resident, gain on the sale of that property is not treated as Puerto Rico-source, even though the general rule sources personal property gains to the seller’s tax home.⁸

The override applies if you were a U.S. citizen or resident (other than a bona fide resident of Puerto Rico) at any time in the 10 years before the sale. That description covers essentially everyone who moves to the island from the mainland. In effect: gains on the investments you carried with you stay federally taxable.

The regulations offer a partial fix through a bifurcation election. You split the gain into a pre-move portion and a post-move portion, and only the post-move portion is Puerto Rico-source and eligible for exclusion. For marketable securities, the split uses the fair market value on the first day of your Puerto Rico residency as the dividing line: appreciation before that date stays U.S.-source, appreciation after that date is Puerto Rico-source. For other property, the split is proportional to holding time — total gain multiplied by the fraction of the holding period during which you were a bona fide resident. You make the election simply by reporting the bifurcated gain on the return for the year of sale.⁸ Investments purchased after you become a bona fide resident don’t fall under the lookback.

Filing Requirements and the Form 8898 Penalty

You have to file Form 1040 if your gross income subject to U.S. tax equals or exceeds the applicable threshold, which generally tracks the standard deduction for your filing status.⁷ Married individuals filing separately have a threshold of just $5.⁴

In the year you become (or stop being) a bona fide resident of Puerto Rico, you also have to file Form 8898 if your worldwide gross income for the year exceeds $75,000. The form goes in separately from your income tax return, by the return’s due date including extensions.⁹ Missing it carries a flat $1,000 penalty per failure, and the penalty applies whether or not you owe any federal tax.¹⁰ Reasonable cause is available but requires a written statement under penalties of perjury.

The larger risk is that the IRS challenges your bona fide residency itself. If the exclusion is disallowed after the fact, you owe the back tax plus accuracy-related penalties and interest running from the original due date, which can eclipse whatever federal tax you thought you were saving.

1
Office of the Law Revision Counsel. 26 U.S. Code 933 – Income from Sources Within Puerto Rico
2
Office of the Law Revision Counsel. 26 USC 937 – Residence and Source Rules Involving Possessions
3
eCFR. 26 CFR 1.937-1 – Bona Fide Residency in a Possession
4
Internal Revenue Service. Publication 1321 – Special Instructions for Bona Fide Residents of Puerto Rico Who Must File a U.S. Individual Income Tax Return
5
Internal Revenue Service. Instructions for Schedule SE (Form 1040) (2025)
6
Internal Revenue Service. About Form 1040-SS, U.S. Self-Employment Tax Return
7
Internal Revenue Service. Publication 570, Tax Guide for Individuals With Income from U.S. Territories
8
eCFR. 26 CFR 1.937-2 – Income from Sources Within a Possession
9
Internal Revenue Service. Instructions for Form 8898
10
eCFR. 26 CFR 301.6688-1 – Assessable Penalties with Respect to Information Required to Be Furnished with Respect to Possessions