“I’ll just write that off.”
Famous last words.
Did you start your own home business during 2020? Or maybe you relocated your business to your home during the pandemic?
There has been a lot of chatter in the news in the past few weeks about the new employee work from home deduction that will be available for the 2020 tax year only. Namely, the federal government has rolled out a new program that provides for a flat rate deduction for employees working from home (up to a maximum of $400) without the need to have any supporting receipts.
But what if you are not an employee, but the owner of the business? In that case, you need to look to a different set of rules.
Conditions for deducting expenses if self-employed
If you are self-employed (i.e., sole proprietor, unincorporated employee, partner in partnership), you are permitted to deduct expenses for the business use of a workspace in your home as long as you meet one of the following conditions:
- it is your principal place of business; or
- you use the space only to earn your business income and use it on a regular and ongoing basis to meet your clients, customers or patients.
For example:
Mary operates a lash extension studio out of her home. She has a spare bedroom upstairs where she sees all of her clients. The room contains her treatment table, all of her supplies, and is also where she typically works on her bookkeeping. The room is not used for any other purpose.
This example actually meets both tests as Mary’s spare room is clearly both her principal place of business and is used only to earn business income and on a regular and ongoing basis to meet clients.
Contrast Mary’s situation with the following example:
June is a copywriter. She often works on her back deck or sometimes on her living room couch. All of her contracts etc. are housed on her laptop, and she does not really need much space to get her work done.
This example is a little harder to nail down. What is June’s principal place of business? Is there any space in her home that is used only for the purpose of her copywriting business?
If you meet the conditions, what do you have to do?
If a self-employed business owner wants to claim home expenses, the specific expenses need to be claimed on the Form 2125 “Statement of Business Activities” (which is filed with your tax return).
The expenses you get to deduct are based on a percentage of your home expenses. For example, if you use a specific room for business purposes, you can take the area of the workspace and divide it by the total area of the house. In the example above, if Mary’s spare room was 11 x 11 feet in a house that was 1500 square feet, then:
Area of workspace (121)/total square feet (1500) = approximately 8%.
The personal use portion of the home would be 92%.
The next step is to apply this percentage to the allowable household expenses. Expenses that are eligible for deduction include the prorated portion of:
- rent
- capital cost allowance
- property insurance
- property taxes
- interest on a mortgage
- operating costs (e.g., heat and light)
In some circumstances, it may also be possible to include a portion of maintenance costs and minor repairs that relate to the workspace.
Canada Revenue Agency has an excellent information bulletin on business use of home expenses, which can be found here.
Keep in mind that business use of home expenses are only one category of expenses that are deductible by business owners. Other expenses (such as office supplies, meals, or travel) may also be deductible but are subject to different rules.
How should you prepare for 2020 tax return season?
I recognize that the filing deadline for self-employed individuals (for the 2020 tax year) is still many months away. However, given that we are now in a new calendar year, it is the perfect time to start gathering documentation for your 2020 tax return. Here are a few suggestions:
- The golden rule on claiming expenses is that you must be able to justify and prove each expense. This means that you need a receipt, and some indication of the business purpose of the expense.
- Remember in school when the math teacher used to tell you to “show your work”? The same rule applies when preparing your tax file. For business use of home expenses, prepare a spreadsheet (or at least have handwritten notes) setting out your calculation of the business portion of your home, and the proration of the expenses. In addition, I sometimes suggest that clients take a picture of the portion of the home that is used for business (on an annual basis). This way, if you are selected for audit, you can immediately provide the auditor with your detailed calculation of expenses, and pictures of what the space looked like during the year in question (which might be different than its current appearance).
If you need help figuring out what to do with an expense, reach out to your bookkeeper or accountant and ask for help. For further information on how a bookkeeper can help out your business, check out the first episode of “The Tax Chick Podcast” – Bookkeeping 101!
The information in this article is not legal advice. We encourage you to consult with your legal advisor for advice specific to you.
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