Business-use-of-home expenses for the self-employed in Canada

If you run your business from home, part of what your home costs can be a business expense. The CRA calls it business-use-of-home expenses, and for self-employed people it is claimed on Form T2125. It is not the same thing as the home office deduction for employees, and mixing the two up is the most common way people get it wrong.

Self-employed or employee: two different rules

• Self-employed (sole proprietor or partner): you claim business-use-of-home expenses in Part 7 of Form T2125, at line 9945 (CRA, business-use-of-home expenses). Nobody signs anything for you.
• Employee: to claim actual home office costs you need Form T2200, signed by your employer (CRA, work-space-in-the-home expenses for employees), and the list of what you can claim is narrower.

This guide is about the first one. If your business is incorporated, the T2125 rules don't apply to it — talk to your accountant about how your company should handle space in your home.

The two tests: you need to meet one

The CRA lets you deduct business-use-of-home expenses if your workspace meets one of these (CRA):

1. It is your principal place of business. Your home is the main place the business is run from.
2. You use the space only to earn business income, and you use it on a regular and ongoing basis to meet clients, customers or patients.

The CRA's technical folio adds detail (Income Tax Folio S4-F2-C2):

• "Principal" means your chief or main place of business. Under the first test, the space doesn't have to be used only for business — a room that's also the guest room can still qualify, with the costs split.
• Under the second test, the space must be a separate area used for the business and nothing else, and the meetings mean in-person meetings with enough regularity for your kind of business. Occasional client visits don't qualify.

A bookkeeper who works from a spare room and has no other office meets test 1. A contractor who has a shop across town and does invoices at the kitchen table on Sundays probably meets neither.

What you can claim

The CRA's list (CRA):

• Maintenance costs: heating, electricity, home insurance, cleaning materials
• Rent, if you rent your home
• Property taxes and mortgage interest, if you own it — the interest part of the mortgage payment only, not the principal (Folio S4-F2-C2)
• Capital cost allowance (CCA) on the business part of the home — but read the warning below before you do

Working out your share

Use a reasonable basis. The usual one is floor area: the workspace divided by the total area of the home (CRA).

An example. You rent a 1,200 sq ft apartment and use a 120 sq ft room as your office, which is your principal place of business.

• 120 ÷ 1,200 = 10%

Your year's costs:

• Rent: $26,400
• Electricity and heat: $1,800
• Tenant insurance: $420
• Total: $28,620

10% × $28,620 = $2,862 of business-use-of-home expenses.

If the room is also used personally

If the space is your principal place of business but the family uses it too, split again by time. The folio says hours per day the room is used for business is a reasonable basis (Folio S4-F2-C2).

Same apartment, but the office doubles as a den. You use it for business 8 hours a day out of 24.

• 10% of the area × 8/24 of the time = 3.33%
• 3.33% × $28,620 = $954

The limit: it can't create a loss

Business-use-of-home expenses can't be more than your net business income before you deduct them. They can't create or increase a business loss (CRA).

Whatever you can't use this year carries forward to next year, as long as you still meet the conditions. The folio adds that carried-forward amounts can only be deducted against income from the same business (Folio S4-F2-C2).

Example: your business earned $1,900 before home costs, and your home costs come to $2,862. You deduct $1,900 this year (net business income: zero), and carry $962 forward.

The CCA warning

You can claim CCA on the business part of a home you own. Most people shouldn't. The CRA says the capital gain and recapture rules will apply to that part of the home when you sell it if you've claimed CCA on it (CRA). The folio lists not claiming CCA as one of the conditions for the CRA to leave your principal residence treatment alone (Folio S4-F2-C2). A small deduction now can cost a lot more at sale. Ask your accountant before claiming it.

Keeping it straight in your books

Home costs are awkward because they're mostly paid from your personal account, not the business one. Two ways to handle them:

• Year-end claim only. Keep the home bills (rent or mortgage statement, property tax bill, utilities, insurance) in a folder and give the totals and your area calculation to your accountant at year end. Nothing goes through the business books during the year.
• Business pays its share. If home bills are paid from the business account, don't book the whole bill as an expense. Book the business share to business-use-of-home and the rest to owner's draw.

Either works. What doesn't work is putting the whole hydro bill through as a business expense because it came out of the business account.

Spark Books keeps personal spending that comes out of the business account in owner's draw rather than in expenses, and its year-end package is mapped to the T2125 lines — so your accountant can add the business-use-of-home calculation on top of clean numbers. It's also on the year-end bookkeeping checklist.

The short version

• Self-employed: T2125, Part 7, line 9945. Employees: T2200, a different set of rules.
• Qualify by being your principal place of business, or a dedicated space where you regularly meet clients.
• Claim the business share of rent or mortgage interest, property tax, utilities and insurance.
• Share = workspace area ÷ home area, and also hours if the room is shared.
• Can't create a loss; the excess carries forward.
• Think hard before claiming CCA on your home.

Spark Books is free bookkeeping for Canadian businesses: upload your statements, and it sorts them into a Canadian chart of accounts with the GST/HST split and personal spending kept out of your expenses.