Home Office Expenses and the Principal Residence Exemption in Canada

If you are self-employed and work from a room in your home, you may have claimed some home expenses on your tax return. When you later sell, a common worry is that those claims turned part of your home into a business asset and cost you the exemption.

In many cases the answer depends on one thing: whether you claimed capital cost allowance, usually called CCA or depreciation. This article walks through how the rules generally work.

This article covers Canadian federal tax law, which applies in every province.

Claiming office expenses is not the same as claiming CCA

If part of your home is used for business and you claim no CCA on it, the home can still be fully designated as your principal residence. Expenses other than CCA may be claimed, subject to the conditions in the CRA folio.

Claiming CCA on the business part, by contrast, can cost you the exemption for that part. Many self-employed people deliberately skip CCA on a home office for this reason. Whether you did claim it is the first thing to check on past returns.

Does a home office count as a change in use?

A change in use, such as a home becoming a rental, is a deemed disposition at fair market value and an immediate reacquisition at the same amount, which becomes the new cost base. For a partial change, the proportionate share of fair market value is used.

For a partial change in use, such as a rented room or a home office, there is no deemed disposition if the rental or business use is relatively small, there are no structural changes and no CCA is claimed. What counts as relatively small is a matter of fact, so a large or exclusive business space is worth reviewing with an advisor.

If you did claim CCA or made the business use larger

Two things can happen. First, the business part may no longer be sheltered. Where only part of a home is the principal residence and the rest earned income, the selling price and adjusted cost base are split by square metres or number of rooms, if the split is reasonable.

Second, a special election may help in some cases. On a change from personal use to income-producing use, you can elect under subsection 45(2) that there be no deemed disposition. You attach a signed letter to the return for the year of the change, describing the property and citing subsection 45(2). No CCA can be claimed on the property, and you may designate it as your principal residence for up to four years while it earns income, if you do not designate another property and remain a Canadian resident. Since 19 March 2019 the 45(2) or 45(3) election is also available for a partial change in use.

The election is not available if CCA was claimed on the property after 1984 and on or before the change in use. If CCA is already in the picture, get advice before you sell.

A quick comparison

Steps to take before and after you sell

• Review past returns to confirm whether any CCA was claimed on the home office.
• Measure the office area against the whole home, or count rooms, in case a split is needed.
• Keep records of purchase costs, improvements and selling costs, because the gain is proceeds minus adjusted cost base and selling expenses.
• Report the sale on Schedule 3 even if the whole gain is exempt, and complete Form T2091(IND) to designate.
• If CCA was claimed or the business use changed the home's structure, speak with an accountant or lawyer before filing.

If a taxable gain arises, one-half of the capital gain is taxable.

Frequently asked questions