More and more of our clients are working from home or establishing home based businesses. These businesses can range from contractors to home day spas to daycare centers. If these businesses rented a space elsewhere, there is a cost associated with renting the space which is a tax deduction. So doesn’t it make sense to deduct the office expenses associated with the workspace in a personal home?
Of course, it does. Expenses related to your workspace (for example, home office or basement) can be deductible for tax purposes. The space should be used in a home on a regular and continuous basis to earn business income and to meet clients, customers, or patients. The expenses must also be reasonable – expenses are prorated based on the portion of your home used as the business space and prorated based on the time spent for business and personal living.
Let’s use an example of two business owners and calculate the home office expenses that can help you save on tax.
Home Business - Consultant
Let’s call the first business owner Daniel. Daniel is a consultant who rents an apartment in downtown Vancouver, which has limited space, and a workspace is set up in the living area. Daniel only works out of his apartment and does not have an established office elsewhere. In addition to paying rent, Daniel pays for utilities and takes out renters' insurance.
Daniel’s total home expenses for the year are $24,800. Using the full amount of expenses is not reasonable as Daniel lives in his home and uses it for personal purposes. As such, Daniel needs to separate his home expenses into a business portion and a personal portion based on the workspace area to the total area of the home.
Daniel’s workspace takes 5.9% of his apartment and the business portion of his home expenses is $1,462. BUT that’s not the eligible deduction. As the workspace is set up in Daniel’s living space, the space is used personally outside of his work hours. Daniel works 8 hours out of a 24-hour day.
Daniel is eligible to deduct $487.45 as home office expenses from the business income he earned.
Home Business - Spa
Our second home business owner is Natalie. She operates a day spa and uses a dedicated room in her home for the spa. Natalie is flexible and can take clients anytime during the day. The spa does not have set hours and the space is not used for personal purposes. Natalie also owns the home and she has several expenses including utilities, insurance, mortgage, and property taxes. Only the interest paid on the mortgage can be included in the calculation (not the full mortgage payment).
Natalie’s total home expenses for the year are $21,000. Similar to our first home business owner, using the full amount of expenses is not reasonable as Natalie lives in her house and uses it for personal purposes. Natalie also needs to separate her home expenses into a business portion and a personal portion based on the workspace area to the total area of the home.
Natalie’s home spa takes 7.5% of her house and the business portion of her home expenses is $1,575. As the spa does not have set hours and is not used for any personal purposes, additional prorated amount related to hours is not necessary. Natalie is eligible to deduct $1,575 as home office expenses from the business income she earned.
What about repairs & maintenance?
During the year, Natalie hired a contractor to conduct annual maintenance on her hot water tank as well as her air-conditioner, which cost her $500. This maintenance is for the whole home and is included in the above calculation. A portion of the $500 is included as a home office tax deduction.
Natalie also hired a contractor to paint her home spa to create a relaxing space for her customers. Would this expense be included as a home office expense? In a nutshell, this is an expense to the business but it is not part of the home office expense. The cost of maintenance and repairs to the business owner’s home are fully deductible where the expense relates specifically to the workspace only. For example, the cost to paint the spa as in Natalie's case, or the installation of office equipment, or repairing a broken sink in the spa, etc. These expenses are not prorated based on the area of the home and are not included in the above calculation. Let's say Natalie paid $1,000 to paint the spa, then the full amount of $1,000 is included in repairs and maintenance expenses on her statement of income.
What about the cost of a phone and internet service?
Daniel decided to get a separate phone for his business, and the phone is dedicated to taking calls from his clients and suppliers. Alternatively, Natalie is using her phone for both business and personal purposes. What is the best way to deduct these costs?
Daniel can deduct 100% of his second phone which is used for business purposes only. Natalie needs to figure out what portion of her phone is used for personal purposes and what portion is used for business purposes. Assuming Natalie splits the usage 50/50, she is only able to deduct 50% of the cost of her phone.
The deductibility of internet service would be similar to the phone example.
Implication for Principal Residence
One of the biggest tax breaks that we Canadians enjoy is the fact that when we sell our principal residences, we do not have to pay taxes on the gains.
You should know that if a portion of a principal residence is used as a workspace to earn income, there is a partial 'change in use' of the principal residence. However, it is not CRA's practice to apply partial change in use rules and the resulting capital gains tax implications, if the following conditions are met:
the income-producing use is ancillary to the main use of the property as a residence;
there is no structural change to the property; and
no capital cost allowance (CCA) is claimed on the property.
If you deduct CCA on the business-use part of your home, capital gains and recapture rules apply when the home is sold. Assuming you don’t want to lose your principal residence deduction, we do not recommend taking CCA on the property. In addition, make sure that your workspace (business use area) is never more than 50% of the total square footage of the home; however, it’s probably safer to keep that percentage even lower.
My Business is Registered for GST/HST
If the business is registered for goods and services tax/harmonized sale tax, a portion of the GST/HST can be claimed as input tax credit on the GST/HST return. The prorated portion of GST/HST is based on the percentage of the area and percentage of business and personal usage.
Some expenses such as mortgage interest, rent, strata fee, etc. do not charge GST. So make sure to review these expenses carefully.
Make sure to keep all of your receipts to support the home office expenses you've claimed. The CRA is focusing more on home office expenses given the trend towards more people working from home or setting up businesses out of their homes.
There you have it – this is how to get a tax deduction for the home based businesses office expenses. Remember to consult a qualified tax professional or accountant for any specific advice relating to your business.