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Capital Gains Tax and Running a Business from Home

July 7th, 2013

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Ok, this is a long blog and I apologise in advance, but if you run a business from home then you need to read this!  It seems every tax seminar I attend lately is highlighting the Capital Gains Tax implications on your family home of running a business from home.  This particular topic has come under the radar of the tax office in recent years due to the growing number of small business owners using their home as a base of operation.

There are TWO main ways to claim business expenses relating to your home.

1.  Claiming occupancy and running expenses using the floor area of your home as a guide.

To use this method, you must pass ‘The Interest Deductibility Test’.  This means you have a home office, workshop or other room set aside exclusively to run your business, and it is not shared with other family members such as your husband, wife or children.  Once you have established that you pass this test then you can claim a percentage of the following expenses:

  • Rates and taxes
  • Emergency Services Levy
  • Interest on your mortgage
  • Rent
  • Water
  • Electricity & Gas
  • Land Tax
  • House insurance premiums
  • Repairs and maintenance to your home office

The percentage you claim will be based on the floor area you use for your business as a proportion of the floor area of your whole home.  For example, if the floor area of your home office is 15% of the total area of your home, you can claim 15% of the expenses listed above such as rates, interest on your mortgage and house premiums.  Note that if your electricity from running your business is high due to the use of power tools or running heating and cooling, then you can work out your electricity claim on an actual cost basis rather than the floor area percentage.  In fact, the Tax Office prefers, in most cases, that electricity is calculated on the actual cost basis.

If you decide to use the floor area method then your home WILL BE subject to capital gains tax when you go to sell.  The percentage rate that you use to calculate your home office expenses will be the same rate you use to calculate your capital gains tax.

2.  Claim the actual cost of your running expenses or use the ATO set rate of 34c per hour

This method is used where you don’t have an area set aside exclusively for business, or you do have an area set aside but you share it with other family members.

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Your home will NOT be subject to capital gains if you fall into this category.

Although you cannot claim home occupancy expenses under this method, you can still claim the following home office expenses:

  • electricity
  • gas
  • depreciation on office furniture

To claim these expenses you can either work out the actual cost of the expense that relates to your business or the ATO has a set rate of 34c per hour to make this calculation easier.

34c per hour: If you decide to use the ATO rate of 34c per hour you will need to keep a diary for 4 weeks to record the hours that you spend working on your business.  Once you work out the average hours you worked over a 4 week period you can use this average as a basis for the entire year.  All you need to do then is multiply the total hours worked for the year by the rate of 34c per hour, and that’s your claim for gas, electricity and office furniture.  Note that you are unable to claim home office expenses using this method if other family members are occupying the room at the same time you are using it to perform business related tasks.

For example, Sally runs a small online business from home.  She has an office that she uses, but her husband also shares this office to work from home on weekends.  Most of Sally’s work is done at the kitchen table or spread out on the lounge room coffee table while no other family member is in the room.  Sally’s diary shows she worked 40 hours in a 4 week period.  This equates to an average of 10 hours per week.  Therefore, Sally’s claim would be 10 hours per week x 52 weeks per year x .34c = $176.80 as a tax deduction for electricity, gas and depreciation on her office furniture.  Note that Sally would need to do a new diary every year showing her usage over a four week period if she continues to use this method.

Actual Cost: If you prefer you can work out the actual hourly cost of your electricity, gas rather than using the ATO set rate of 34 cents per hour.  This can be a little tricky as it will vary depending on what room of the house you were working from at the time and whether you were using heating or cooling. 

So here comes the warning! 

If you pass the ‘Interest Deductibility Test’ in number 1 above, but you choose not to claim home occupancy expenses, it doesn’t exclude your house from capital gains tax.  Many people believe that if they don’t make the claim for occupancy expenses, then they save their house from capital gains tax. Trust me, if you have an office set aside exclusively to run your business and you don’t make one single claim for home office expenses in your tax return, your house may still be liable for some Capital Gains Tax.

 

My suggestions:

1.  Get a valuation on your home as soon as you start using a separate room in your home exclusively to run your business.  Then get another valuation when you stop using that room or you cease business.  If you don’t do this then the ATO will average out your capital gain over the period you owned your home, and this could result in you paying tax on a much larger capital gain.

2.  Talk to your accountant about your home office and make sure you are clear on how your accountant is claiming your home office expenses.  I’m amazed at how many business owners have no idea of the percentages that their accountant is using as a basis for working out their home office claims.  Discuss whether it’s worth subjecting your house to capital gains or whether you may be better off just working from the kitchen table, sharing your home office with family, and claiming 34c per hour as a tax deduction.

3.  Measure your home office accurately.  If using your floor area to claim your expenses, use the floor plan of your house to work out a precise floor area.  Don’t just take a guess, because if the ATO come knocking they will expect to see exact measurements.

 

8198668_sAnd lastly remember this.  It can be hard when you work from home, and you don’t have a home office.  The kids are loud; the house is a mess, and there is nowhere to close the door and retreat.  And who really wants to share their well organised office with their spouse just to avoid capital gains tax?  A separate home office to shut yourself away is imperative for some people and the benefits can clearly outweigh the costs.   Financial decisions can be as much about lifestyle as they are about saving money.  Sometimes we have to take the path that may not be so cost effective to enable us to live and work comfortably.

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