Home Office Tax Deduction
Own a business, or intend to do so? Write off part of the costs of your home.
Eligibility for claiming Home Office Expenses
The expenses related to your home must be incurred for a space exclusively for business – whether to earn a taxable business income, or in reasonable expectation to earn a business profit.
When a home-office expense would satisfy the “exclusive use test”, so as to be otherwise deductible, it must also satisfy one of the two tests:
A. Office must be the individual’s “principal place of business”, OR
(Income Tax Act, R.S.C. 1985, c. 1, s. 18(12)(a); Interpretation Bulletin IT-514, “Work space in home expenses”, (1989))
B. If the office is not the principal place of business, it must be “used on a regular and continuous basis for meeting clients, customers or patients” or used exclusively for the purpose of earning business income.
(“Principal” is not defined. It is considered by CRA to have a meaning similar to “chief” or “main”)
Types of Expenses Deductible for Home Office
- Utilities: power, water, heat, gas
- Internet
- Maintenance done to your home
- Insurance
- Property taxes, condo/management fees, etc.
- Some other odd expenses related to your home, such as related professional fees
- Mortgage interest, or rent
- CCA; depreciation of your home (4% of value)
The calculation of the business use part is done using the floor area (e..g. sq. ft.) of your home and the associated space. For example:
Power, water, gas: $200/month
Insurance: $50/month
Property tax: $250/month
Mortgage interest: $700/month
Total: $1,200/month
Home total area: 2,100 square feet
Business use part (e.g. basement): 700 sq. ft.
Part of home used for business: 700/2,100 = 1/3.
Total business use part: $1,200 x 1/3 = $400
Total home office business expense for the year: $4,800
Income for the year, gross: $60,000
Income for the year, net: $55,200
Marginal tax rate (Alberta plus Federal): 30.5%
CPP rate: 10.50% (Employer plus Worker portions)
Taxes and CPP saved: $1,968 (41% of $4,800)
CCA is optional, but most people do not claim it. If the taxpayer sells the home for more than what the taxpayer claims the home is worth, after the depreciated claimed amounts, half of the difference becomes taxable (business part). However, being able to claim 4% of the property value can result in present-year immense tax savings.
What if Part of this Space at Home is also Subject to Personal Use?
If you also use this space for other purposes, then you can be allowed the claim, in part (or all, depending on your argument). You can either establish that:
A) You use such space exclusively for business only, OR
B) You use X part of such space exclusively for business only (e.g. half of this space).
You’ll be compared to others in your occupation with a similar home layout, and past rulings for the calculation of what is deemed “reasonable”.
It is noteworthy that you can presently have $0 business income, but still can claim (but carry forward to future years), if the expenses for the office space are incurred in expectation of profit.
Reasonable Expectation of Profit Test
One can technically be not bringing in business income and still be eligible to claim expenses related to the business, home office or not. The expenses must be incurred to reasonably expect to earn business income; incurred to pursue profit.
Pursuit of Profit Test
This test mainly considers whether the expense incurred has a personal part to it. If there is not, then there is no further analysis. The following two-stage approach can be employed:
(i) Is the activity of the taxpayer undertaken in pursuit of profit, or is it a personal endeavor?
(ii) If it is not a personal endeavor, is the source of the income a business or property?
The objective factors considered:
(1) the profit and loss experience in past years,
(2) the taxpayer’s training,
(3) the taxpayer’s intended course of action, and
(4) the capability of the venture to show a profit.
… This “pursuit of profit” source test will only require analysis in situations where there is some personal or hobby element to the activity in question… Where the nature of an activity is clearly commercial, there is no need to analyze the taxpayer’s business decisions.
Stewart v. Canada, 2002 SCC 46
Other factors considered to determine whether an expense is personal or business:
– the time required to make an activity of this nature profitable,
– the presence of the necessary ingredients for profits ultimately to be earned,
– the number of consecutive years during which losses were incurred,
– increase in expenses and decrease in expenses in the course of the relevant periods,
– the persistence of the factors causing the losses, the absence of planning, and the failure to adjust.
Tonn v. R, 1995 CanLII 3566 (Federal Court of Appeal)
What is “Maintenance” for Home Office?
Home maintenance are expenses incurred for the upkeep of your home (or in this case, related to your office space claimed). That is, expenses to maintain the condition of your home, and are not capital improvements that add value to your home, and have a lasting purpose.
Capital improvements adding value, are instead claimable only for business, rental, or investment purposes – in part, as capital cost allowance (“CCA”; depreciation). In those cases, they are claimable only in part – depreciated over years. Typically property is allowed only 4% per year in deductions, but certain items such as appliances fall into another CCA Class, with higher allowed rates.
Examples of current maintenance expenses:
- Repair of leaking roof.
- Painting, where your old walls’ paint is fading/chipping off.
Examples of capital expenditures, only claimable as CCA:
- Bathroom improvement renovations.
- New decorative flooring and walls.
Note: CCA functions by declining balance: you carry forward the unclaimed amount of the item, and then claim the rate on the new remaining balance the year after. Repeat for each year you continue to use the item.
For example:
You spent $10,000 on bathroom renovations. CCA claimable @ 4% = $400. Year 1: Claim $400. Remaining balance: $10,000 - 400 = $9,600. (i.e. To CRA, your bathroom renovations depreciated by $400, and is now worth $9,600.) Year 2: Claim 4% of $9,600 balance; $384. New balance: $9,600 - 384 = $9,216. Claim 4% on this next year, and so forth.
“[a]n expense that simply restores a property to its original condition is usually a current expense…” and that “[t]he cost of repairing a property by replacing one of its parts is usually a current expense.”
Canada Revenue Agency (“CRA”)
Example Case of Home Maintenance Expense vs. Capital Expenditure
House was cribbed, jacked up, and existing footings were straightened and reinforced with some more cement. Issue between CRA and taxpayer: - Are these current maintenance expenses, or capital expenditures only claimable in part? — Water pump and tank under house were repaired — Electrical wiring was replaced — Taxpayer appealed CRA assessment that disallowed deductions for costs of repairs and maintenance — Appeal allowed — Repairs did not improve house beyond its original condition in any manner — Costs of repairs and maintenance, though all done at once, were properly deductible as current expenses and were not required to be capitalized. Martinello v. the Queen, 2010 TCC 432
Example Calculation, with Home Maintenance
Electrical repairs: $600
New flooring: $3,000
Part of home used for business: 500 / 2,500 sq. ft. = 1/4
CCA claimable for flooring: 4% of $3,000; $120
Total claimable: [$600 + 120] x 1/4 = $180
Why CCA is Often not Claimed
If you later dispose of property claimed as CCA (e.g. trade, or sell), you may be subject to a capital gain (half taxable) or capital loss.
A capital gain occurs when you dispose of property for more than its depreciated balance.
Example:
Home value, Year 1: $600,000 Business use part: $150,000 (1/4 of home) CCA claim: 4% of $150,000 = $6,000. Remaining balance, business use part: $150,000 - 6,000 = $144,000 Home is sold in Year 2 for $650,000. Business use part: 1/4 of $650,000 = $162,500 Capital gain: $162,500 - 144,000 = $18,500 Taxable amount: 1/2 of $18,500 = $9,250 So in the first year, you claim to have a cost of CCA of $6,000. In the 2nd, you profited $18,500 from its sale, for which half ($9,250) is additional taxable income.
A capital loss occurs when you dispose of property for less than its depreciated balance.
Example:
Home value, Year 1: $600,000 Business use part: $150,000 (1/4 of home) CCA claim: 4% of $150,000 = $6,000. Remaining balance, business use part: $150,000 - 6,000 = $144,000 Home is sold in Year 2 for $550,000. Business use part: 1/4 of $550,000 = $137,500 Capital loss: $137,500 - 144,000 = -$6,500 Tax deductable amount: 1/2 of -$6,500 = -$3,250 So in the first year, you claim to have a cost of CCA of $6,000. In the 2nd, you had an additional capital loss of $6,500 - half tax deductible. Instead of claiming CCA in Year 2, you now claim half of this loss.
