Tax breaks for the home office crowd

Hundreds of thousands of Canadians keep an office in their home that can legitimately qualify for some kind of tax break.
Statistics Canada estimates that about a third of all self-employed people work from home. ((iStock))
Hundreds of thousands of Canadians keep an office in their home that can legitimately qualify for some kind of tax break.

You probably know someone in this category — your uncle Irving with the home-based consulting business, your cousin Mary the freelance writer, or your neighbour Fred the telecommuting employee. Each of these people may be able to reduce their tax bill by deducting all or part of the costs of earning income from work they do in their own home.

But beware: the tax policies in this area can be tricky and the tax benefits only go to those who successfully manoeuvre their way through the intricacies of the Canada Revenue Agency. Even after those conditions are met, other rules kick in to limit how much can be deducted in any one year.

Simply having a home office isn't enough to generate some favourable tax treatment. Getting a break from the tax department depends entirely on what you use your home office for, as well as the nature of your work status. Most employees, for instance, can't deduct home office expenses unless they are required to maintain a home office by their employer (more on that later).

It's far more advantageous, at least from a home office tax perspective, if you are self-employed.

Self-employment and the home office

Self-employment is the fastest growing category of employment in this country, with more than two million people falling into this category. Statistics Canada estimates that about a third of all self-employed people work from home. For some Canadians, the journey into self-employment was launched after their previous job disappeared in the recession. For others, the freedom of being their own boss was the main driver. But no matter what the reason, the ability to claim home office expenses is a big selling point for the home-based entrepreneur.

Self-employment: By the numbers
 Number of self-employed who work from home: 711,705 
 Average hours per week worked: 40.6
 Average total income in 2005: $32,789
 Number of home-based self-employed who made more than $80,000 in 2005: 48,100
 Number who made less than $5,000: 92,045
 Source: 2006 Census

But not every home office qualifies for tax breaks.

The Canada Revenue Agency will allow you to deduct eligible home office expenses from home-based business income if one of the following two conditions is met:

  • The home office must be the "principal" place of business. That means more than 50 per cent of the time.
  • The home office is used exclusively for earning income and "on a regular and continuous basis" for meeting customers and clients.

Once either condition is satisfied, then eligible home expenses related to that home office can be deducted from business income. But there's a big catch: The home expense deduction relating to the cost of living in the home cannot be used to create a tax loss (or increase a loss) for tax purposes.

So if your home business had a net profit of $10,000 (before home expenses are taken into account) and you have $12,000 in eligible home expenses, you can't report a $2,000 loss. What you can do, however, is report a zero income from the home-based business (applying $10,000 of the expenses to the $10,000 of income) and carry forward the excess $2,000 loss to the following tax year, providing you still have a qualifying home-based business. 

What kind of expenses can be deducted?

Self-employed individuals pay a price for their freedom They aren't eligible for employment insurance and they have to pay twice the CPP premiums that employees do. But unlike employees, they also enjoy a wide range of reasonable home expense deductions that can be claimed. The key word here is "reasonable." Claiming home office expenses that are out of line with other tax filers in the same line of work invites an audit.

How much you can deduct depends on how much of your house your home office occupies. If the home office occupies a tenth of the square footage of the total home area (excluding hallways, bathrooms and kitchens), then a tenth of the home's expenses can be deducted. (In Quebec, only 50 per cent of eligible home maintenance expenses can be deducted). Some of the eligible expenses for the self-employed crowd include:

  •     Utilities (heat, electricity, water, gas).
  •     Property taxes.
  •     Home insurance.
  •     Mortgage interest (but not principal).
  •     Condo fees and rent.

Home office expenses that are specifically related to the home-based business don't need to be pro-rated; they can be deducted in full. A business phone, printer paper, and toner cartridges would fall into this category. Those are some of the more obvious business expenses. But there are others.

"If you increase your mortgage to help finance the start-up of your business, that portion of the mortgage interest that relates to the business is a business expense which you can deduct regardless of whether or not your business is profitable," writes accountant Stephen Thompson in his 167 Tax Tips for Canadian Small Business 2009 (John Wiley & Sons).

And remember to keep your receipts to back up all expense claims. The CRA doesn't like rough guesses. Form T2125  has a part that deals with the calculation of what it calls "business-use-of-home expenses".

What about furniture and computers?

The cost of big-ticket items like desks or computers normally can't be entirely written off in one year since they provide an ongoing benefit to the business. They must be depreciated over several years through a process called capital cost allowance.

The speed of the writeoff depends on the class of asset. For instance, office furniture has a CCA rate of 20 per cent. So that $1,000 desk normally results in a $200 deduction (except in the year of purchase, when only half of the normal CCA rate applies.)

Tax tip
If your home insurance goes up because of your home-based business, you can deduct 100% of the increase.
Source: 167 Tax Tips for Canadian Small Business by Stephen Thompson

Computer hardware usually has a CCA rate of 45 or 55 per cent. But under a special provision in the Jan. 27, 2009, budget, computers bought after budget day and before Feb. 1, 2011, have a 100 per cent CCA rate.   

Can I claim depreciation on my house?

Yes, but most tax experts say you shouldn't. Claiming capital cost allowance on that portion of one's home that is occupied by the home office risks a potentially bigger tax bill later on.

"If you claim CCA, the CRA will take the position that that fraction of your home is not part of your principal residence and will disallow your claim for the principal residence exemption for that portion of the home," according to KPMG's Tax Planning For You and Your Family (Carswell). "Any CCA you claimed can also be 'recaptured' into income when you sell your house."

KPMG outlines only one scenario where it might make sense to claim CCA on your principal residence: where you bought your home at the top of the market and expect to sell at a loss.

What about telecommuters?

Many Canadians work from home but are not self-employed. They are employees who work for companies that have either encouraged or allowed them to work from home instead of travelling to an office to work. Can they deduct their home office expenses? 

Yes, but only if a few conditions are met. For one thing, you must satisfy the same workplace conditions that self-employed workers are. That means the home office must be where more than 50 per cent of work is done, or the workspace is used exclusively to earn income and is used on a regular basis for meeting clients or customers.

But for employees, there's more fine print. Your employer must require that you work from home. Your employer is also required to fill out Form T2200 (Declaration of Conditions of Employment).  The first question asks employers if "this employee's contract requires the employee to pay his or her own expenses while carrying out the duties of employment?" If the answer is no, the employee can't claim employment expenses. The second question asks if the employer requires the employee to "work away from your place of business." 

But let's assume that your employer has signed the T2200. You can then deduct many of the same home expenses that self-employed individuals can. That includes pro-rated shares of the home's utilities costs, cleaning materials and minor repairs. But employees are not allowed to deduct CCA, taxes, insurance or mortgage interest costs. Commission sales employees with qualifying home offices have a little more leeway; they can deduct "a reasonable portion of the taxes and insurance paid," according the CRA.