Home Office Expense DEDUCTION

Prior to 1988, there were no restrictions on deducting home office expenses to offset other earned income. Since 1988, some restrictions apply.

CRA's Guide T4002 tells us you can take the home office expense tax deduction if you meet one of the following conditions:

1. It is the principal place of business [where principal means your chief or main place of business more than 50% of the time]; OR
   
2. The space is used exclusively to earn business income on a regular AND continuous basis for meeting clients, customers or patients [on the premises].

CRA's (Canada Revenue Agency) definition of a meeting makes it very difficult for sole proprietors to claim the home office deduction using option two.

A December 2020 blog by Blue J (a legal technology company) entitled, Home office deduction - When is a meeting not a meeting? explains CRA's definition of a meeting. The issue stems because the phrase "meeting customers" is not defined in the ITA (IncomeTax Act).

Torkin Manes April 2020 blog "What Expenses Can You Claim For Your Home Office?" explains CRA's "longstanding administrative position of what constitutes a meeting. ... a “meeting” must involve two or more persons in the same place [a face-to-face event], despite case law [Landry v. The Queen] which suggests that a telephone call [for the purposes of subparagraph 8(13)(a)(ii)] constitutes a meeting for those purposes." 

Tax Interpretation 2013-0481171E5 E Home Office Expenses discusses whether "meeting customers" should include modern technology and include meetings by such means as email, telephone, and Skype. This interpretation mentions that "section 18.28 of the Tax Court of Canada Act states that informal Tax Court of Canada decisions should not be treated as a precedent for any other case" (referring to Landry v. the Queen decision?).

Tax Interpretation Neal Armstrong's News of Note dated February 16, 2014 titled Telephoning is not meeting someone reported "Notwithstanding some Tax Court decisions (e.g., Glen) finding that the phrase can include telephone meetings, CRA considers that “the phrase ‘meeting customers or other persons’…includes only face to face encounters.”"

Mr. Armstrong went on to describe when a phone-in could be argued as valid. "This arguably suggests that a directors’ meeting physically conducted in, say, Luxembourg, but with Canadians phoning in, qualifies as a meeting held in Luxembourg – at least, where two of the directors are face-to-face in Luxembourg."

In general, the implication is that virtual or telephone meetings do not count. To my knowledge, CRA has still not revisited its interpretation of "meeting" given how technology has changed current business practices allowing for virtual meetings as a normal course of business. It's unclear whether CRA would reconsider its position if you were to include virtual meetings using online conferencing platforms. If you operate a virtual business, you would have to discuss with your accountant whether your virtual meetings count as a meeting enabling you to claim this option for your home office expense deduction.

We need to break this down to determine how you qualify under this criteria for the home office expense deduction.

If you:

• use part of the home for both business and personal living (i.e., you do not have an area not exclusively used to earn business income), OR
• have an exclusive work area BUT you do not "meet" (per CRA's definition of a meeting) customers on a regular basis on your premises,

you must prorate your claim based on hours of use in a day and days of use in a week. Here's the steps to making the option one proration for your tax return.

If you are a virtual business (do business over the internet and through online meetings) you would fall in this category as you are not "meeting" customers on your premises.

AUDIT READY

If you are able to claim under criteria one, Canadian tax expert Evelyn Jacks recommends in Master Your Taxes you make and date a sketch of the business use area in relationship to the personal living space of the house. Keep it on file in the event of an audit to provide support documentation for your claim. It would also be a good idea to take photos of your home office workspace for your file. This will be especially important and valuable if you move after filing a tax return based on that location.

Both conditions must be met to use this option. It's not as straightforward as it looks given how CRA interprets meetings.

First, the work space must be segregated and used only for business and no other purpose. This means your family members can't use it in the evenings or weekends and guests can't sleep on the sofa bed when they are in town. The closet can't be used as a spare closet for non-business stuff. It must be used exclusively for business and separate from your family living space.

The second part of this criteria is regular and continuous meetings on the premises. In this instance you want to ensure you keep an appointment log as proof for CRA if audited. You might even want to consider having your clients sign in the log when they come to your office. A business journal is also a good idea.

AUDIT READY

This means if you regularly meet your clients utilizing online meeting technology such as GoToMeeting, Zoom or some other platform, you DO NOT meet the regular meetings criteria and must claim your home office expense deduction using option one not option two.

It also means that if you have a business that has infrequent or irregular meetings, you DO NOT meet this criteria and you must prorate your claim based on hours of use in a day and days of use in a week method used in option one.

If you do qualify to use this option, here's the steps to making the option two proration for your tax return.

Once you determine you have met the criteria to claim the business use of home expense tax deduction, be aware the deduction has limitations. Your tax software will automatically apply these limitations.

The deduction for home office expenses cannot be used to create or increase a loss for income tax purposes. However, it can be carried forward indefinitely if you are unable to use it in the current year AND continue to meet the criteria to make the claim.

Any carried forward expenses will have to be used up in any year there is business income, to reduce your income to zero.

If you cease this business, the carry forward deduction is lost. It cannot be transferred to another business startup operating from the same residence.

AUDIT READY

Be aware that your home telephone line, consumed supplies and similar expenses are not deductible under this section as they do not relate to the work space itself. Income Tax Folio S4-F2-C2, Business Use of Home Expenses 2.32 and 2.33 says the business portion may be deducted as a regular business expense.

I probably don't have to say this, but just in case, you can only deduct an expense of any kind ONCE ... so if you claim something under business use of home expense, it cannot be deducted anywhere else!

In British Columbia, you can apply to defer your property taxes beginning at the age of 55 ... although I don't know why you would want to as it may affect your future borrowing power against your home equity in times of emergencies.

Banks like to have first claim to your collateral. I have a friend who is a bank manager and she says they would want you to pay off your back taxes before they would consider loaning you money with your home as collateral. That would be awful news to hear if you are having a financial crisis and need to borrow money.

Anyway, if you do go this route, it's my understanding your deferred property taxes are still claimable. What I'm unsure about is whether the grants should reduce the claim. [Sidebar: I live in Alberta now and dearly miss my homeowner grants.]

I like to be conservative in my tax saving strategies (it's just my nature and I can't afford to be the one to challenge the government) so I would reduce the taxes to the amount I actually paid. Why? Because all rebates, grants, assistance must offset the expense or be claimed as income. Read more here in point 2 of non-deductible business expenses.

However, keep in mind that I'm not a tax expert. Sometimes I don't understand the nuances that tax professionals are trained in even after it is explained to me. At those times, I just rely on their expertise. That's why it's so important to always check in with your tax accountant to get customized advice.

CRA IT-533 Bulletin - Interest Deductibility and Related Issues defines interest as having to meet three criteria.

1. The amount must be calculated on a day-to-day accrual basis.
2. The amount must be calculated on a principal sum.
3. The amount must be compensation for the use of the principal sum.

In more general terms here are the deductibility rules:

• Mortgage Interest: You cannot deduct mortgage payments of your home. However, you are allowed to deduct a part of the interest part of your mortgage. The deductible portion is usually based on the percentage of your home that is used for your business activity. 
  
  Stephen Thompson in 167 Tax Tips for Canadian Small Business 2009 explained that if you increase your mortgage to finance the start-up of your business (as opposed to personal debt), the portion of the mortgage interest that relates to the business is 100% deductible as a business expense. If that applies, the interest expense would be reported on line 8710 not here.
  
  
• Rent Expense: If you rent your home, you can deduct a portion of the rent for your home office. The amount you can deduct is usually based on the proportion of your home that is used for your business.
  
  
• Home Line of Credit: It is my understanding If you use a home equity line of credit (HELOC) for business purposes, you might be able to deduct the interest. However, it should be noted that this interest would likely need to be directly tied to expenses from your business. The CRA would require you to demonstrate that the funds were used for business purposes. If that applies, the interest expense would be reported on line 8710 not here. The interest on a general secured line of credit against your home is not considered a mortgage, as far as I know and therefore not deductible.
  
  

It's key to note that mortgage interest is only a deduction if you met the criteria to claim the home office expense deduction.

You must only include expenses that relate to the whole house or your home office in particular. Costs related solely to personal use areas are to be excluded ... this means you CANNOT just take a percentage of the total home maintenance costs.

Always keep in mind the general rule - personal use expenses are NEVER deductible for business purposes.

If you are operating your business from your home, be sure your policy includes coverage for operating a business from your home. You would hate to invalidate a policy just because you didn't know any better. If there is ever a major event, you can bet the insurance agent will look around to find a reason to deny a claim. An unreported, uninsured home based business is a reason to deny your claim.

The additional business coverage is 100% deductible under your regular business expenses on line 8690, not as part of the home office expenses. If you are in any kind of consulting capacity, expect to be required to provide proof of professional liability or errors and omissions insurance coverage. 

Any expense related to separate coverages listed in your policy for personal property items should NOT be included in the proration of your home insurance for this calculation.

I strongly recommend you read the following articles at Michael James on Money:

• house insurance for home based business; and
• an explanation of insurance company squeamishness about home business.
  

Assuming the business is a GST/HST registrant and that they qualify for the home office expense deduction, then consider one of the following:

If you want to book the utility expenses monthly to your books, prorate the amount at the time you book the entry. For example, if you were eligible to claim 10% for home office expenses, a hydro bill for $400 before 5% GST would be recorded:

DR Home Office Expenses 10% excluding GST/HST ITC = $40
DR Owner's Draw 90% including GST/HST ITC = $360 x 1.05 = $378
DR GST Payable (for ITC's) 10% = $40 x 5% = $2
CR Cash in Bank 100% = $400 x 1.05% = $420

At year-end, reconcile the home office expense account to the T2125 and adjust accordingly.


If you do it as an annual entry, then calculate the amount on the T2125. Once that is done, book an entry something like this into the books:

DR Home Office Expense $xxx split from T2125
DR GST Payable (for ITCs) $xxx split from T2125
CR Owner's Contribution $xxx total of T2125

Honestly, the only reason I would book these expenses monthly would be to reduce data entry at year-end as well as reduce the likelihood of the client losing the paperwork.

Sole proprietors claiming their home office expenses do so on the T2125 schedule of the T1 income tax and benefit return. I don't usually record the amount in the books.

IF you feel you really want to show your home office expenses on your income statement, I'd create the home office expense account BELOW the line as an "other expense" type of QuickBooks account. Your entry would be:

DEBIT Home Office Expense (amount calculated on your T2125 schedule)
CREDIT Owner's Contribution

As I said, I normally don't bother recording this expense on my books because if I didn't have my business, I'd still be spending the same amount of money ... 

Remember there is often a difference between book and tax for bookkeeping purposes.