Home Office and the Principal Residence Exemption in Canada

If you are self-employed and work from a room in your home, you may wonder whether deducting home office costs will cost you the tax-free sale of your home later. The worry is common, and the answer depends on how large the business use is, whether there are structural changes, and whether you claim capital cost allowance (CCA).

This article explains the general federal rules from the Canada Revenue Agency (CRA). It cannot replace a review of your own deductions, so use it to prepare questions for your accountant or lawyer.

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

The short answer: expenses are different from CCA

If part of the home is used for business and no CCA is claimed on it, the home can still be fully designated as a principal residence. Expenses other than CCA may be claimed, subject to the conditions in CRA's folio guidance. Claiming CCA on the business part can cost the exemption for that part.

Does business use trigger a deemed sale?

A change in use, such as a home becoming a rental, is generally 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.

There is relief for small uses. For a partial change in use, such as a rented room or 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. Since 19 March 2019, an election under subsection 45(2) or 45(3) is also available for a partial change in use.

What counts as relatively small is a question of fact, so a lawyer or accountant should look at the share of the home used and how you use it.

If you have already claimed CCA

The subsection 45(2) election lets you treat a change from personal to income-producing use as no deemed disposition, but you cannot claim CCA on the property while it is in effect. The election is not available if CCA was claimed on the property after 1984 and on or before the change in use, whether by you, your spouse or common-law partner, or a trust of which either is a beneficiary.

If you did claim CCA on the office space, the business part of the home may be treated differently on sale. 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.

Reporting the sale

• Since the 2016 tax year, the sale of a principal residence must be reported on Schedule 3 of the T1 return, even if there is no gain or the whole gain is exempt.
• Individuals designate the property and calculate any gain on Form T2091(IND).
• On Schedule 3, the designation is made in Part 1 by ticking box 1 at line 17900 if the home was the principal residence for all years owned, or all but one, or box 3 if it was not the residence for every year.
• A gain on an income-producing portion goes on line 13800.
• Half of a capital gain is taxable.

Only one property per family unit can be designated for each year from 1982 onward, so a cottage or second home can affect how you use the exemption on your main home.

What to do next

• Review past returns to see whether you ever claimed CCA on any part of the home.
• Measure the business area in square metres or count the rooms used, and keep notes on how much of the time it was used.
• Record any structural changes made for the business.
• Keep records of purchase costs and improvements to support your adjusted cost base.
• Before you claim CCA in future, talk with an accountant or lawyer about the trade-off for the exemption.

Frequently asked questions