Consider these tips and traps when using your home for business

My friend Jesse started a part-time business last year. “Tim, I took your advice and launched a business. I’m selling weigh scales. I order specialized digital equipment that can measure weights in very small increments, and I sell them to labs, jewellers and other businesses” he said. “That’s great, Jesse! How’s it going so far?” I replied. “Great. But I’d call the business a small-scale operation,” he said. Clearly, it wasn’t the first time he’d used that dad joke.

Last week, I suggested that a part-time business can do wonders when economic uncertainty hits because it can provide extra cash while opening the door to deducting things you’re paying for anyway – like home and vehicle costs. Today, let me expand on the idea.

The tax impact

Jesse went on to tell me that his business is not profitable yet but should be soon. So, for his 2024 tax year, he’ll be reporting a small loss. Now, there are a couple of things to understand about our tax law if you start a business and report losses, which is common in the early years.

First, those losses can be applied to offset other income. For Jesse, he still reports employment income (he has another job). His losses amounted to about $6,000 for 2024, which will save him about $2,700, at a marginal tax rate of 45 per cent, when he files his 2024 personal tax return.

Next, you can’t create or increase a business loss using your home office expenses. To be allowed a deduction for home-office expenses, your home must either be your principal place of work (more than half your business working time must be there) or a space designated solely for your work and used on a regular and continuous basis for meeting customers or clients.

If you meet the test, you can deduct a portion of home-related costs such as mortgage interest, rent, utilities, home insurance, property taxes, internet, phone, cleaning materials, repairs and maintenance related to your office area, as well as supplies used in the business. You can claim these amounts to bring your business income down to zero, but not to create a loss, and any excess expenses can be carried forward indefinitely to claim in a future year (report these costs on Form T2125 in the year you incur them; in Part 7 of that form you’ll calculate the portion of home-related costs, if any, to carry forward).

As for vehicle expenses, you can claim a portion of these as well if your vehicle is used in the business. Unlike home office costs, these costs can create or increase a loss from the business.

The tax issues

If you started a business in 2024, report that activity on Form T2125 even if you didn’t earn much or any revenue last year. Any losses will help you save tax. How many consecutive years can you show a loss before the taxman gets concerned? There’s no single answer, but if you report losses for two or three years in a row, you might receive a letter from the Canada Revenue Agency letting you know that they’ve noticed. Should this concern you? Not necessarily. Let me explain.

In 2002, the Supreme Court of Canada handed down a decision in the case Stewart v. Canada (2002 SCC 46), which provides the criteria that the CRA – and the courts – must consider when evaluating business or rental losses.

The Stewart case established that if an endeavour is commercial in nature, with no personal element to it, then a “source of income” exists. Where a source of income exists, the CRA must allow reasonable expenses incurred for the purpose of earning that income – even if these expenses create a loss. The CRA cannot disallow losses just because it believes there is no reasonable expectation of profit.

But you’ll have to show a sufficient degree of commerciality to demonstrate that your intention is to generate a profit. If losses are denied, it’s typically because there is some personal element to the activity or the endeavour is fully or partially a hobby.

The last thing I’ll say is this: If you carry on your business from home, you’ll want to preserve your principal residence exemption to allow a tax-free sale of your home at some point. You can do this if you avoid making structural changes to your home to create a dedicated business space, avoid claiming capital cost allowance (depreciation) on any part of your home and keep the business portion of your home to less than half so that your business use is ancillary to the use of the home as your principal residence.

Tim Cestnick, FCPA, FCA, CPA(IL), CFP, TEP, is an author, and co-founder and CEO of Our Family Office Inc. He can be reached at [email protected].