Is the Home-Office Deduction Worth it?

By Randall Orser | Small Business

There’s been much speculation about the Federal Liberals and their approach to home-based businesses with them possibly taxing you when you sell your home (principal residence), as your either ran a business out of it or rented part of it out. We’ll talk about the home-office deduction as it relates to business for now. It still could be worth taking.

If you’re working out of your home, it pays to look into the tax deductions available for home office expenses. Even though Canada Revenue Agency has recently tightened its rules regarding these expenses, you can still save significant tax dollars by taking advantage of home office deductions whenever they’re available to you.

If you have an office in your home, and it qualifies as a “home office” for income tax purposes, you can claim a portion of your ongoing home expenses. The portion will normally be based on the fraction of the home that is used for your office (you can usually exclude common areas, such as hallways, kitchen and washrooms, when making the calculation). The fraction of your home can be based on either square feet or the number of rooms.

Your home expenses can add up to quite a bit today, as mortgages are higher and you’re paying more interest (wait until rates go up), property tax and city utilities continue to climb, and insurance rates go up; so, it can add up to quite a bit. Some people can spend quite a bit on their home expenses in a year.

The expenses you can claim include:

· rent, if your home is rented

· mortgage interest (but not the principal portion of blended mortgage payments) for self-employed individuals only

· property taxes

· utilities: electricity, heat, water

· telephone (if you have a separate business telephone which is fully deductible, consider whether you also use your personal phone for business calls)

· outside maintenance: lawn care, snow plowing

· minor repairs and supplies

· home insurance.

These expenses can add up to $20,000 or more per year. Even if you’re only claiming 10%, that’s $2,000 off your net income, and $2,000 you’re not taxed on. Of course, the savings go higher, the more you use your home for business. However, be careful how much you use as depending on your business, too high and it could flag you with CRA.

Currently, you might convert a portion of a principal residence to an office or other work space to use for the purpose of earning income from a business. In such a case, a partial change in use of the principal residence will occur for income tax purposes. This will give rise to capital gains tax implications as described in Income Tax Folio S1-F3-C2, Principal Residence. However, it is the CRA’s practice not to apply the partial change in use rules and 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 is claimed on the property.

Whether the use of a work space in a home is secondary to the main use of a home as a residence in any particular case is a question of fact. For example, an individual may convert a portion of a principal residence to a bed and breakfast. In order to have no change in use, it must be determined that the bed and breakfast operation is secondary to the main use of the property as your principal residence.

Now if the government does change its mind and tax you on when you run a business out of your home, then sell that home, you will incur a capital gain based on the percentage of the home you used for business. How much is this going to cost you? Well, that depends on many factors. Here’s a quick example.

Joe Smith has been running a business out of his home for 10 years, and has owned the home for 20 years. He feels it’s time to sell as the home is worth so much more than what he paid for it, and doesn’t need as much space with the kids gone. Joe ends up selling for $1.5 million. He bought the place for $175,000 and put about $50,000 into over the years, for a total of $225,000; his costs to sell were $100,000 (including realty & lawyer fees). That gives him a total cost base of $325,000. His gain is $1.175 million. His business used 25% of the home, therefore, he will be taxed on that portion which equals $293,750. Since Joe is married and his wife is an owner they split this gain.

As you can see this could add up to a lot of taxes owing when you sell your home.

Anything with government can change at the drop of a hat, or a change in who’s running the country. The Federal Liberals haven’t at this moment put up plans to tax Canadians, however, that could change. I believe a change will come after the next election if the Liberals win, and you will be taxed if you ran a business out of your home and sell it. I believe, eventually, we’ll be taxed on the sale of our homes period; there’s just too much money at stake.

Our governments are broke and looking for money, why wouldn’t they when they spend like drunken sailors on leave.

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