If you’re self-employed and have a home office, you pay expenses to run and maintain that space each month. You can deduct some of these expenses on your taxes — which means that you can subtract them from your net income on your tax return and reduce the amount of taxes you owe at the end of the year. The Canada Revenue Agency (CRA) has criteria in place that determines whether or not you can claim this deduction.
Understanding Business Use of Home Expenses
When you run a business from your home, your work area is subject to costs such as utilities, home maintenance, mortgage interest, and property taxes. The CRA considers these business uses of home expenses and allows you to deduct them from your income taxes The logic behind the deduction is that if you paid rent and common services in a commercial building, you could obviously deduct the expenses. When you run a home office, the same principle applies, but the calculations prove a bit more detailed.
Keep in mind that these deductions only apply to the part of your home you use for business. That means that you can’t deduct your entire electricity bill — you can, however, deduct the percentage of the bill that applies to your home office. To figure out what percentage you can deduct, the CRA recommends using a basis such as the square feet of your home office divided by the total square feet of your residence. You can report these expenses as a deduction when you file your taxes.
Who Can Deduct Business Use of Home Expenses?
The CRA has specific restrictions for the business use of home deduction. According the Income Tax Act, you must meet two fundamental criteria to claim the deduction. First, you must use the space as your principal place of business. That means you must spend more than 50% of your work time there. Second, you must use the space occupied by your office or workshop almost exclusively to earn business income. In other words, if you use a corner of the dining room table in the daytime, you can’t claim that space on your tax return. If, however, you dedicated a specific room in your home to your small business, that room qualifies. You can qualify for the deduction no matter what your field — everyone from home-based physicians to web designers can claim the home office deduction.
Deductible Business Use of Home Expenses
When you run a business from your home, many of the expenses you pay qualify for the business use of home tax deduction. What’s more, you can deduct a percentage of just about any amount you spend on your home. The CRA specifies that if you claim an expense in another place on your tax return, you can’t also claim it as a home business expense.
Eligible business use home expenses for some fairly obvious deductions, including:
- Interest on mortgage payments
- Municipal and school taxes
- Home or renter’s insurance
- Utility bills
- Electricity, gas, or heating oil
- Phone service
- Internet service
You can also deduct some slightly less obvious expenses, such as:
- Current repairs and general upkeep
- Cleaning services
- Cleaning supplies
Do you rent your home? If so, you should also include rent as a business expense. If you own your home, you should include property taxes and capital cost allowance. If you want, you can also deduct part of your home’s cost as depreciation. Keep in mind, though, that the CRA may recapture this amount and tax it as income if you sell your home.
Calculate the Business Use of Home Deduction Percentage
Before you use the business use of home deduction, you need to figure out what percentage of each bill you can deduct. The CRA doesn’t have a hard and fast rule for how you calculate this percentage. You must, however, use a reasonable method for the type of business you have. What’s more, you must apply this method consistently and coherently each time you file your taxes.
Deducting a percentage of your home expenses equal to the percentage of your home’s total area that you use for business proves the most common method. For example, if your home office takes up 10% of your home’s total area, then you can reasonably deduct 10% of your allowable expenses. That means if your rent runs $1,800 per month, you may write off $180 in rent per month as a business expense — assuming you use the space exclusively as an office. The CRA almost always accepts this calculation method due to its simplicity and straightforwardness.
Sometimes, this method doesn’t work. Imagine you run your business from a detached garage, for example, or if your back garden is part of the company. In this case, you might need to factor in the area of the outbuilding or land to get an appropriate percentage. Each case is different, but if the method proves reasonable under the circumstances, the CRA should usually accept it.
Calculating Home Business Deductions for Shared Spaces
If your home office doubles as a guest room, lounge, or personal area, you need to take your calculation a step further by factoring in how much time you spend working there. To do so, count the hours per day you use the room for work, and then divide that number by 24. Multiply the result by the area-based deductible expense.
Imagine your home office takes up 25% of your home. If you pay $1000 per month in rent, that means you can deduct $250 as a business expense. Since you only use the room for 8 hours per day, however, you can’t deduct the full $250. In this case, you should divide 8 by 24 to get .33 — in other words, you only use the space as an office 33% of the time. To get your final deduction, multiply .33 by $250 to get $82.5. This is the amount of rent you can deduct as a business expense each month. Form T2125, Statement of Business and Business Activities, has a chart to help you with these calculations.
Exceptions to Your Home Office Deduction Percentage
Sometimes, your general deduction percentage is too low. That means that for some expenses, you can deduct a higher percentage. Usually, this happens when you use the product or service more for business and less for personal purposes. Take telecommunication services, such as internet and telephone services. If you run an internet-based business, you may reasonably consider deducting a higher percentage — after all, you probably use these services largely for your business. If you have a business phone line you use only for work, you can deduct 100% of the cost. The same goes for office supplies so long as you use them only for your business activities.
Claiming the Business Use of Home Deduction
When preparing your tax return, you must complete and join Form T2125 (Statement of Business and Professional Activities) to claim your business use of home deduction. This is the general form for a sole proprietorship and includes the deduction for home office expenses. Report your expenses in Part 7 of the form. You must separate each cost by category, including heat, electricity, insurance, etc. For miscellaneous expenses, you must provide a basic description to the CRA.
Keep in mind you can’t use home office expenses to create or add to a loss. That means you can only claim up to the amount of income your business generates. For instance, imagine your home business brought in $10,000 one year, but you had $15,000 in deductible expenses. In that case, you can only claim a deduction of $10,000.
If you don’t have enough business income to claim the full amount, you can carry the rest of the deduction forward to the next year. In the case above, imagine your business made $50,000 in the second year along with another $15,000 in deductible expenses. You could deduct that $15,000 plus the remaining $5,000 from the first year to reduce your taxes. As a result, you would have just $30,000 in taxable income.
Can Employees Deduct Home Office Expenses?
If you work from home for an outside employer, you’re usually responsible for many of your own home office costs. Your employer might cover your internet or phone, for example, but your company probably doesn’t pay your renter’s insurance. Before the 2018 tax year, you could claim these expenses as deductions on your taxes, but for all years after 2018, you can’t deduct these unreimbursed costs. If you run a business and hire employees that work from home, you may need to cover their expenses in lieu of the tax deduction.
Record-Keeping for Business Use of Home Deductions
As a taxpayer seeking a deduction, you must keep records of each business expense. That means you should keep receipts, invoices, and documentation for any expense you plan to claim. This includes electricity bills, receipts for office supplies, and invoices from your cleaning service. Do you pay rent? If so, be sure to ask your landlord for a receipt so you can prove your expenses to the CRA. This holds true for any expense you plan to deduct.
To make tax filing easier, consider tracking your expenses in a program such as QuickBooks Online. These records can help you calculate your total deductions each year. If you’re audited, an organized system can help you prove your deductions to the CRA, which makes the process move faster.
How Does the CRA Verify Home Office Deductions?
When you claim deductions for your home office expenses, it’s important to be accurate and truthful — particularly when it comes to the size and usage of your work area. If your kids use your office as a playroom, for example, it might be tempting to claim you use it exclusively as an office. However, if the CRA looks through your public social media accounts and sees multiple photos of your children playing on the computers or watching TV, they may dispute your claim. They may also go through your receipts, check your income figures, or even send an official to your space during an audit. If you claim exclusive business use of a space on your tax return, it’s a good idea to keep the entire space free of personal items.
As a small business owner, tax deductions make a great way to reduce your net income and your taxes. By tracking and deducting the expenses you pay for your home office, you can enjoy a lower tax burden when you file your annual return. QuickBooks Online can help you maximize your tax deductions. Keep more of what you earn today.