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CRA gives your home a break

Ever since leaving my last job, I now meet people quite regularly at my home for business purposes. My wife Carolyn has noticed this, of course, and has suggested that I might want to help more when it comes to keeping the home clean. Now, I'm the first to admit that I don't help out enough around the house, and I've been feeling guilty about that.

So, last week Carolyn arrived home to find some men in our front hall.

"Tim, there are half a dozen men downstairs with vacuum cleaners. They say they have appointments with you. Are these more clients of yours?" Carolyn asked.

"No," I replied. "But I did ask them to come today to give demonstrations. Gimme a hand will you? Put them in different rooms and tell them to get busy."

Now, if you use your home for business too, be sure to ask the question: "Will this jeopardize a tax-free sale of my home later?"

The law

When you decide to use a portion of your home as an office, a partial "change in use" occurs under Canadian tax law. In this case, paragraph 45(1)(c) of our tax law causes a deemed disposition of that portion of the property. That is, our tax law considers you to have sold that portion of your principal residence at fair market value.

You're probably already aware that when you sell your principal residence, it can be a tax-free sale, thanks to your principal residence exemption. So, even though this deemed disposition takes place when you change the use of part of your home to an office, your principal residence exemption may be available to shelter that change in use from tax.

This change in use is more of a concern if you convert that home office back into a principal residence. In that case, there's another deemed disposition of that portion of the property at fair market value. Since that portion of the home has been used for business purposes, the principal residence exemption may not be available to shelter the tax at that time.

All of this can cause problems for a lot of people. And so, the tax collector has adopted an administrative policy, which I think you're going to like.

The policyIn Interpretation Bulletin IT-120R6, paragraph 32 (available at http://www.cra.gc.ca), the Canada Revenue Agency (CRA) has spelled out its administrative policy on this issue. The CRA says "it is our practice not to apply the deemed disposition rule, but rather to consider that the entire property retains its nature as a principal residence, where all of the following conditions are met: (a) the income-producing use is ancillary to the main use of the property as a residence, (b) there is no structural change to the property, and (c) no capital cost allowance (CCA, which is depreciation for tax purposes) is claimed on the property."

There you have it. Just because you start using part of your home as an office for your business does not mean you'll have to pay tax on that part of your home when you sell it later. You can continue to call the entire property your principal residence as long as you meet the three conditions outlined by the CRA above.

Who says the CRA has no heart? Remember, it's not our tax law that provides this favourable treatment. Rather, it's simply the way the CRA has chosen to administer the law. By the way, this administrative policy applies equally to employees who are required to have an office at home, and to those who rent out part of their home.

Tim Cestnick, FCA, CPA, CFP, TEP, is a tax specialist and author of Winning the Tax Game 2005 and The Tax Freedom Zone.

tim@timcestnick.com

© The Globe and Mail

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