Income Tax Folio S4-F2-C2, Business Use of Home Expenses

Series 4: Businesses

Folio 2: Deducting Business Expenses

Chapter 2: Business Use of Home Expenses

Summary

Expenses incurred in earning income from a business are normally deductible in computing income to the extent they are reasonable. This Chapter deals with the conditions and restrictions placed on the deductibility of business expenses that relate to the use of an office or other work space in an individual’s home. The work space must be used for specified purposes and the expenses deducted relating to that use must not exceed the individual’s income from the business for a tax year (computed without reference to certain amounts). This Chapter also deals with the carryforward of any excess to the immediately following tax year.

This Chapter is applicable to individuals who are a sole proprietor or a partner in a partnership . For information concerning the deductibility of expenses relating to an employee’s use of an office or other work space in the home, see Interpretation Bulletin IT-352R2, Employee’s Expenses, Including Work Space in Home Expenses, the Canada Revenue Agency (CRA) webpage Work-space-in-the-home expenses or Guide T4044, Employment Expenses.

For a general overview of the deductibility of business expenses relating to the use of an office or other work space in the home, see Business-use-of-home expenses. For an example of how to calculate business use of home expenses, see Calculating business-use-of-home expenses. Where the work space relates to a home daycare business, see the CRA webpage Daycare in your home.

For information regarding home office and other types of expenses that are eligible for deduction by a sole proprietor or a partner in a partnership, see Guide T4002 Business and Professional Income or the CRA webpage Business expenses. The tax implications arising from the use of a principal residence for income-producing purposes are outlined in Income Tax Folio S1-F3-C2, Principal Residence.

The CRA issues income tax folios to provide technical interpretations and positions regarding certain provisions contained in income tax law. Due to their technical nature, folios are used primarily by tax specialists and other individuals who have an interest in tax matters. While the comments in a particular paragraph in a folio may relate to provisions of the law in force at the time they were made, such comments are not a substitute for the law. The reader should, therefore, consider such comments in light of the relevant provisions of the law in force for the particular tax year being considered.

This Chapter can be relied upon as an accurate official summary of the CRA’s interpretation of the law from the date of Application.

Discussion and interpretation

General limitations for deducting expenses

2.1 An individual can deduct expenses incurred in earning income from a business or property, subject to satisfying various requirements under the Act. In order to be deductible as a current expense, an outlay or expense must meet at least the following general requirements :

it must be made for the purpose of gaining or producing income from the business or property (paragraph 18(1)(a));
it must not be on account of capital (paragraph 18(1)(b);
it must not be made for the purpose of gaining or producing exempt income (paragraph 18(1)(c));
it must not be a personal or living expense (paragraph 18(1)(h); and
it must be reasonable in the circumstances (section 67).

2.2 In addition to meeting each of these general requirements, the requirements outlined in subsection 18(12) must also be met in order to deduct business use of home expenses . Where a work space in the home is used for the purpose of earning income from property, see Expenses incurred in earning income from property.

Subsection 18(12)

2.3 In computing an individual’s income from a business for a tax year, subsection 18(12) provides that no deduction may be claimed for expenses related to the use of any part (referred to in the Chapter as a work space) of a self-contained domestic establishment where the individual resides, unless certain conditions are met.

2.4 Specifically, paragraph 18(12)(a) provides that in order to deduct expenses related to a work space, the work space must be:

the principal place of business of the individual (subparagraph 18(12)(a)(i)); or
used exclusively to earn business income and used on a regular and continuous basis for meeting clients, customers or patients of the individual in respect of the business (subparagraph 18(12)(a)(ii)).

2.5 Where the requirements described in ¶2.4(a) or (b) are met, an individual can deduct eligible expenses related to the use of a work space in the home for the year. The deduction is subject to certain restrictions that are discussed in ¶2.37 – 2.39.

Self-contained domestic establishment

2.6 The expression self-contained domestic establishment is defined in subsection 248(1) as a dwelling-house, apartment or other similar place of residence in which place a person as a general rule sleeps and eats. A residence is considered to be a self-contained domestic establishment if it is a living unit with restricted access that contains a kitchen, bathroom, and sleeping facilities. A room (or rooms) in a hotel, dormitory, boarding house or bunkhouse would not ordinarily be a self-contained domestic establishment.

Bed and breakfast operations

2.7 Whether a residence or a portion of a residence constitutes a self-contained domestic establishment is a common question that arises in respect of bed and breakfast operations . The term bed and breakfast generally refers to a business involving the provision of overnight accommodation, including breakfast, by an individual in his or her home. An owner’s living quarters in a bed and breakfast will not usually be a self-contained domestic establishment. This is because the owner does not usually have separate facilities (such as a kitchen or laundry) or living areas (such as a dining or living space) that are private (that is, restricted from guest access) and apart from the rest of the residence.

2.8 As a result, it is the CRA’s view that the following income tax treatment will generally apply to a bed and breakfast operation:

the entire residence in which a bed and breakfast operates will be a self-contained domestic establishment within the meaning assigned by subsection 248(1);
the portion of the residence used in a bed and breakfast operation will be a work space within a self-containeddomestic establishment to which subsection 18(12) will apply;
the expenses that may be deducted in a year relating to a bed and breakfast operation will be limited to the income for the year from that operation, pursuant to paragraph 18(12)(b) (discussed further in ¶2.37 – 2.39);
expenses not deducted in the year by reason only of paragraph 18(12)(b) will be deemed an expense from the operation in the immediately subsequent tax year, pursuant to paragraph 18(12)(c) (discussed further in ¶2.40 – 2.42).

2.9 Ultimately, whether living quarters constitute a self-contained domestic establishment is a determination of fact. Although the general treatment of bed and breakfast operations for tax purposes is outlined in ¶2.8 , the CRA recognizes an exception in situations that fall within the same fact pattern as in Sudbrack v The Queen, [2000] 4 CTC 2668, 2000 DTC 2521 where subsection 18(12) was found not to apply.

Fiscal year-end of business

2.10 Where an individual’s income for a tax year includes income from a business the fiscal period of which does not coincide with the calendar year, a reference in this Chapter to a tax year should be read as a reference to a fiscal period of the business ending in the tax year.

Principal place of business

2.11 Where an individual has two or more places of business in respect of the same business, the work space must be the principal place of business in order to meet the requirement described in ¶2.4(a). The word principal is not defined in the Act but in this context is generally understood to refer to the individual’s chief or main place of business .

Example 1

Mr. A is a building contractor who uses a work space in his home to perform various administrative activities that are required in his business operations. These activities include receiving work orders, bookkeeping, ordering supplies and preparing payrolls. The remaining activities of the business, the performance of contracts, are carried out at various customer locations. The work space in Mr. A’s home therefore represents his main place of business. Mr. A’s children often use the work space in the evening to do their homework.

A work space need not be used exclusively for the business in order to meet the principal place of business requirement outlined in ¶2.4(a). This means that the room used by Mr. A in his home to perform the administrative functions of his business will be considered Mr. A’s principal place of business.

In light of the personal use of the space, Mr. A will, however, have to apportion his expenses as discussed beginning in ¶2.18.

Example 2

Ms. B is a lawyer who operates a law practice in a rented commercial office space near her home. She also has a work space in her home. She uses the work space to work from home on Fridays and in the evenings and weekends when necessary. The work space has a hide-a-bed that is used by Ms. B’s family and friends when they visit. Ms. B almost exclusively meets clients at her rented office space.

Ms. B’s rented office space will be considered her principal place of business. This means that the requirement in subparagraph 18(12)(a)(i) will not be met. The requirements in subparagraph 18(12)(a)(ii) are also not met as the work space in the home is not used exclusively for business purposes and on a regular and continuous basis for meeting clients. Ms. B cannot deduct expenses relating to her business use of the work space in her home.

Regular and continuous basis

2.12 In order to meet the requirements outlined in ¶2.4(b), the work space must be used:

exclusively to earn business income; and
on a regular and continuous basis for meeting clients, customers or patients of the individual in respect of the business.

2.13 A work space will be used exclusively to earn business income if it is a segregated area, such as a room or rooms, that is used in a business and for no other purpose.

2.14 The Act does not specify what is meant by the wording meeting clients, customers or patients, so the CRA looks to the ordinary or dictionary meaning of these words. The term meet is generally defined as to come face to face with or to come into the presence or company of (someone) by chance or arrangement. The term meeting is generally defined as an assembly or gathering of people by chance or arrangement. It is the CRA’s view that this traditional interpretation of the term meeting, being those held in person, applies for purposes of subsection 18(12).

2.15 Whether a work space is used to meet clients, customers or patients with sufficient regularity and frequency to meet the requirement in ¶2.4(b) depends on the nature of the business activity and the facts of each situation . However, a work space in respect of a business which normally requires infrequent meetings or frequent meetings at irregular intervals will not meet this requirement.

2.16 A work space in the home that is not a principal place of business (see ¶2.4(a)) but is used by a doctor to meet an average of five patients a day for five days each week would clearly be used for that purpose on a regular and continuous basis as described in ¶2.4(b). On the other hand, if that work space is used to meet one or two patients a week, it would not be considered to be used on a regular and continuous basis.

Expenses eligible for deduction

2.17 The expenses related to a work space that are eligible for deduction could include, for example, the prorated portion of :

rent
capital cost allowance (see ¶2.31, ¶2.43 and 2.44)
property insurance
property taxes
interest on a mortgage or hypothec
operating costs (such as heat and light)

Maintenance costs and minor repairs to an individual’s home that relate to a work space may also qualify as a business use of home expense.

Apportionment of expenses

2.18 The expenses should be apportioned between business and non-business use on a reasonable basis. A reasonable apportionment would be the area of the work space divided by the total finished area of the home (including areas such as hallways, bathrooms and kitchen). Other allocation methods may be considered reasonable depending on the particular circumstances . However, the reasonable basis should also take into consideration the personal use, if any, of a work space that is an individual’s principal place of business.

2.19 To clarify, a work space that is an individual’s principal place of business may be used for personal purposes since there is no requirement that the work space be used exclusively for business in order to meet the test described in ¶2.4(a). On the other hand, a work space that is not an individual’s principal place of business must be used exclusivelyfor the purpose of earning income from business and therefore, may not have any personal use.

Example 3

Mr. C has a work space in his home that is not his principal place of business. The work space is used exclusively for business purposes and on a regular and continuous basis for meeting clients of his business. The work space occupies an area of 350 square feet of Mr. C’s 2,000 square foot home. Annual household expenses of a type that are eligible for deduction total $10,000.

A reasonable apportionment of expenses would be:

350/2,000 square feet × $10,000 expenses = $1,750.

The portion of annual household expenses eligible for deduction that relate to the work space is therefore $1,750.

2.20 Where a work space that is an individual’s principal place of business is also used for personal purposes, expenses should be apportioned between business and personal use. A reasonable basis of apportionment may be based on the number of hours a day a room is used for business purposes. If the business operates for only part of the week or year, expenses should be reduced accordingly.

Deductibility of rent expense

2.21 If a work space is part of a home rented by an individual, a reasonable portion of the rent expense is eligible for deduction. However, no deduction can be made for the rental value of the work space area in a home owned by an individual. With the exception of rent, expenses described in ¶2.17 are deductible whether the individual owns or rents the home.

Deductibility of interest on a mortgage or hypothec

2.22 In order to deduct interest on a mortgage or hypothec relating to a work space in the home, the interest must also meet the requirements for deduction under paragraph 20(1)(c). Information concerning the application of paragraph 20(1)(c) can be found in Income Tax Folio S3-F6-C1, Interest Deductibility.

2.23 Generally, interest expense is considered a capital expenditure that is precluded from deduction by paragraph 18(1)(b). However, interest is deductible if the requirements of paragraph 20(1)(c) are met and the deduction is not otherwise precluded by another provision of the Act.

2.24 Among the requirements in paragraph 20(1)(c) is the requirement that an amount be paid in the year or payable in respect of the year, pursuant to a legal obligation to pay interest on borrowed money used for the purpose of earning income from a business or property. The relevant use is the current use and not the original use of borrowed money. In determining the current use of borrowed money, a taxpayer must establish a link between the money that was borrowed and its current use.

2.25 Interest arising on borrowed money used to purchase a principal residence will not generally qualify for deduction Under paragraph 20(1)(c) because the borrowed money will not be used for the purpose of earning income from a business or property. However, where a portion of an individual’s home is used as a work space (that is, an income-earning use), a portion of the interest arising on the borrowed money used to purchase that home may be deductible as a work space expense. To be deductible as a work space expense, such interest must otherwise be deductible under paragraph 20(1)(c) in computing income from that business. The portion of the annual interest expense arising on a mortgage or hypothec that may be deducted should be determined as described in ¶2.18 – 2.20.

2.26 An individual may borrow money under a line of credit that is secured by the individual’s principal residence. Whether interest on that borrowed money is deductible under paragraph 20(1)(c) is a mixed question of fact and law. If borrowed funds on a line of credit secured by an individual’s principal residence are used to pay for personal items such as vacations or home improvements unrelated to the work space (such as a swimming pool installation), the portion of interest expense on the line of credit relating to those purchases will not be deductible for income tax purposes.

2.27 If borrowed funds on a line of credit secured by an individual’s principal residence are used to pay for outlays or expenses related to the work space (such as office equipment and furniture), the portion of interest on the line of credit relating to those purchases may be deductible as a work space expense. A deduction is subject to the apportionment requirement described in ¶2.18 – 2.20 if the funds are used for something that benefits the home and the work space (such as the purchase of a new furnace or air-conditioner). The tracing/linking of borrowed money to an eligible use where a single borrowing account such as a line of credit is used for both eligible and ineligible purposes can be complex and the onus is on the taxpayer to trace/link borrowed funds to an eligible use. Please refer to ¶1.28 – 1.43 of Income Tax Folio S3-F6-C1 for additional information.

Deductibility of maintenance costs or minor repairs

2.28 The cost of maintenance or minor repairs to an individual’s home may be deductible as a work space expense where the expense relates to the use of the work space. These expenses generally fall into one of the following categories:

maintenance or minor repairs that relate to the work space only – for example, repainting the work space, or repairing walls or ceilings following the installation of phones, fax machines or other office equipment used in the work space. These expenses do not usually need to be apportioned for business and non-business use (as described in ¶2.18 – 2.20) unless the work space is also used for personal purposes .

maintenance or minor repairs that relate to the work space as well as other areas of the home – for example, regular maintenance or minor repairs to the home furnace or air-conditioner or the purchase of household cleaning supplies . Such expenses should generally be apportioned as described in ¶2.18 – 2.20.

maintenance or minor repairs that do not relate to the work space – for example, repainting a bedroom. Such expenses are generally precluded from deduction by paragraphs 18(1)(a) or 18(1)(h).

2.29 Whether maintenance or minor repairs can be deducted as a business use of home expense is a mixed question of fact and law to be determined on the facts and circumstances of each particular case.

Expenses not eligible for deduction

2.30 Expenses that may not be deducted as business use of home expenses include outlays on account of capital, expenses not related to an individual’s work space, and personal or living expenses.

Outlays on account of capital

2.31 Certain items typically acquired for use in a work space in the home may be considered to be on account of capital and precluded from deduction by paragraph 18(1)(b). Examples of such items include computers, printers, filing cabinets, chairs, desks and lamps. Since these properties wear out or become obsolete over time, individuals can usually deduct the cost over a period of several years. For more information, see Claiming capital cost allowance (CCA).

Expenses not related to a work space

2.32 The cost of telephone and internet service, consumed supplies (such as pens, pencils, paper clips, stationery, and stamps) and other similar expenses may relate to the business, but they do not relate to the work space. Expenses of this nature are not subject to the requirements in subsection 18(12) and may be deducted as a regular business expense.

2.33 To the extent that telephone and internet service at an individual’s home is used for both business and personal purposes, only the business portion of the expense will be deductible. A reasonable basis of proration should be used to determine the portion of any usage attributable to the individual’s business.

Personal or living expenses

2.34 Expenses relating to an individual’s home that are personal or living expenses are specifically precluded from deduction by paragraph 18(1)(h).

2.35 The term personal or living expenses is defined in subsection 248(1) to include:

“… the expenses of properties maintained by any person for the use or benefit of the taxpayer or any person connected with the taxpayer by blood relationship, marriage or common-law partnership or adoption, and not maintained in connection with a business carried on for profit or with a reasonable expectation of profit.”

2.36 Generally, an expense is incurred in connection with a business if there is a business purpose or need for the expenditure. In relation to this, the Supreme Court of Canada stated in Symes v Canada, [1993] 4 SCR 695, 94 DTC 6001:

“… Would the need exist apart from the business? If a need exists even in the absence of a business activity, and irrespective of whether the need was or might have been satisfied by an expenditure to a third party or by the opportunity cost of personal labour, then an expense to meet the need would traditionally be viewed as a personal expense.”

Restriction on deduction

2.37 An individual who carries on a business in a work space and has met the test described in either ¶2.4(a) or (b), may deduct business use of home expenses that are otherwise deductible (see ¶2.1). However, pursuant to paragraph 18(12)(b), such expenses are only deductible to the extent that they do not exceed the income for the tax year from the business carried on in the home or elsewhere, determined prior to deducting expenses related to the work space and without reference to section 34.1.

2.38 As a result, expenses relating to the use of a work space cannot create or increase a loss for income tax purposes from the business for which the work space is used.

2.39 In general terms, section 34.1 provides rules for computing the business income of an individual who carries on an unincorporated business in the year with a fiscal period that does not coincide with the calendar year. For more information regarding the operation of these rules, see Guide RC4015, Reconciliation of Business Income for Tax Purposes.

Carry forward of undeducted expenses

2.40 Paragraph 18(12)(c) provides rules for the carry forward of business use of home expenses incurred but not deducted in a tax year due to the restriction in paragraph 18(12)(b) (discussed in ¶2.37 – 2.39). Specifically, paragraph 18(12)(c) provides that the portion of the expenses related to a work space that cannot be deducted in a tax year by reason only of the restriction in paragraph 18(12)(b), will be deemed to be an expense related to the work space in the immediately subsequent tax year.

2.41 Where in that immediately subsequent tax year the test described in ¶2.4(a) or (b) is met:

the portion of the expenses carried forward and any further actual expenses incurred in the year can be deducted to the extent permitted by paragraph 18(12)(b); and
any excess of these expenses not deducted in the year can be carried forward to the following year.

2.42 Consequently, business use of home expenses incurred but not deducted in a particular tax year:

may be carried forward indefinitely provided either ¶2.4(a) or (b) is met on a continuous basis;
must be deducted in the earliest subsequent tax year in which there is business income against which to deduct the expense; and
may only be deducted on a carryforward basis from income from the same business in respect of which the work space in the home was used in the prior tax year(s).

Example 4

Mrs. D is self-employed and operates a nail salon business in the basement of her home. The expenses of the business exceed her income from the business in Year 1 and Year 2. As a result, Mrs. D has $900 in business use of home expenses to carry forward. In Year 3, Mrs. D’s business earns a profit of $800 before deducting further actual business use of home expenses in Year 3 of $400.

Mrs. D must deduct $800 in business use of home expenses in Year 3.

The balance of $500 (that is, $900 + $400 – $800) may be carried forward to Year 4.

Example 5

Assuming the same facts as Example 4, Mrs. D decides to close her nail salon business in Year 4 and replace it with a home-based wedding planning business. The business use of home expenses carried forward from Year 3 of $500 cannot be applied against income from the new wedding planning business. This is because business use of home expenses carried-forward can only be applied to income from the same business in respect of which the work space in the home was used in the prior year(s).

Change in use of a principal residence

2.43 An individual 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 pursuant to paragraph 45(1)(c). 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.

2.44 Whether the use of a work space in a home is ancillary 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 under paragraph 45(1)(c), it must be determined that the bed and breakfast operation is ancillary to the main use of the property as the individual’s principal residence.

Expenses incurred in earning income from property

2.45 Subsection 18(12) limits the deduction of expenses related to the use of a work space in the home in computing an individual’s income from a business. Subsection 18(12) does not limit the deduction of expenses incurred to earn income from property. This means, for example, that subsection 18(12) would not apply to expenses incurred for a work space in the home used for the management and accounting activities related to a non-business rental property.

2.46 Expenses relating to the use of a work space in the home that are incurred for the purpose of earning income from property are deductible where they meet the general requirements for deduction under the Act. The deductible portion of such expenses must be determined on a reasonable basis, as described in ¶2.18 – 2.20.

Application

This updated Chapter, which may be referenced as S4-F2-C2, is effective October 3, 2017.

When it was first published, it replaced and cancelled Interpretation Bulletin IT-514, Work Space in Home Expenses.

The history of updates to this Chapter as well as any technical updates from the cancelled interpretation bulletin can be viewed in the Chapter History page.

Except as otherwise noted, all statutory references herein are references to the provisions of the Income Tax Act, R.S.C., 1985, c.1 (5th Supp.), as amended and all references to a Regulation are to the Income Tax Regulations, C.R.C., c. 945, as amended.

Links to jurisprudence are provided through CanLII.

Income tax folios are available in electronic format only.

Reference

Subsection 18(12) (also sections 34.1 and 67, paragraphs 18(1)(a), 18(1)(b), 18(1)(c), 18(1)(h), 20(1)(c) and 45(1)(c) and the definition of personal or living expenses and self-contained domestic establishment in subsection 248(1)).

Link to Source:https://www.canada.ca/en/revenue-agency/services/tax/technical-information/income-tax/income-tax-folios-index/series-4-businesses/series-4-businesses-folio-2-deducting-business-expenses/income-tax-folio-s4-f2-c2-business-use-home-expenses.html

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