(Posted August 2024)
We often see candidates struggle with understanding the technical surrounding the deductibility of home office expenses. This blog summarizes the key technical you need to know when addressing this personal tax issue on the CPA Common Final Examination (CFE) and considerations for your writing approach.
Home Office – Employee
To be able to deduct home office expenses from employment income, the employee must have been required by his/her employer to work from home.
One of the following conditions must also be met to be able to claim workspace-in-the-home expenses:
- The workspace is where the employee mainly (more than 50% of the time) does their work.
- The workspace is only used to earn employment income. It must be used on a regular and continuous basis for meeting clients, customers, or other people in the course of the employee’s employment duties.
Employees must also obtain a signed Declaration of Conditions of Employment (T2200) form from their employer to claim eligible expenses. Examples of expenses that can be deducted include the cost of rent, electricity, heating, maintenance, and a reasonable monthly home internet access fee relating to the workspace. CCA and mortgage interest cannot be claimed. If the employee earns commission income, the employee can also claim property tax, home insurance, and rented equipment. Eligible expenses must be allocated between the workspace and the personal space of the home on a reasonable basis, such as relative floor space or number of rooms.
The amount that can be deducted cannot exceed the amount of employment income earned less employment expenses claimed (i.e., home office expenses cannot be used to increase or create a loss). Unused amounts can be carried forward indefinitely and deducted in a subsequent year, provided the workspace continues to meet the conditions above and there is sufficient net income to offset the home office expense claim.
Home Office – Self-Employed
For a contractor to be able to deduct expenses related to the business use of a workspace in their home, one of the following conditions must be met:
- It is the principal place of business, or
- The space is used only to earn business income and it is used on a regular and ongoing basis to meet customers.
For a space to be considered the principal place of business, the sole proprietor would need to be performing the majority of business activities in the home office (i.e., invoicing, telephone calls, record keeping, payroll, etc.) such that the workspace is the only “office” used in the business.
Items that may be deducted include rent (if tenant), utilities (heat, electricity), home insurance, repairs and maintenance (e.g., minor repairs, cleaning materials), housing supplies, property taxes, mortgage interest, and capital cost allowance (CCA) on the house itself. A reasonable proration should be used to determine the portion of any usage related to the business.
(Note: The cost of telephone and internet service may relate to the business, but they do not relate to the workspace. Expenses of this nature are not subject to the requirements in Income Tax Act (ITA) subsection 18(12) and may be deducted as a regular business expense.)
Only the business portion of the home office expenses may be claimed and is determined on a reasonable basis, such as by calculating the percentage that the area of the workspace used in the business is of the total area of the contractor’s home. However, to avoid a capital gain and recapture on a later sale of a principal residence, it is recommended that the sole proprietor avoid deducting CCA on the business use of the home.
The amount that can be deducted cannot exceed the net income from the business (i.e., home office expenses cannot be used to increase or create a business loss). Unused amounts can be carried forward indefinitely and deducted in a subsequent year, provided the workspace continues to meet the conditions above and there is sufficient net income to offset the home office expense claim.
Case Writing Tips
To ensure you get appropriate depth when writing about home office expenses, consider the following:
- Is the person an employee or contractor, and do they earn commission income? You need to understand the appropriate context so you apply the correct technical to the situation.
- Use the specific facts provided in the case to determine what expenses can be deducted depending on the situation. Apply those case facts to the technical to explain which costs are deductible.
- Address as many of the expenses as you are able in the time you have allotted.
- Quantify the impact where you are able. If you are given specific case facts on the costs and the workspace, determine the amount of the deduction.
Home office expenses and other more specific tax technical topics are discussed at length in our Scenario Flowcharts Workbook, which is included in our CFE Prep courses, and in the Densmore Competency Map Study Notes publication.