Carrying on a business at or from your home Tax information specific to carrying on a business at or from your home.

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1 business SEGMENT Home based small businesses AUDIENCE guide FORMAT NAT PRODUCT ID Carrying on a business at or from your home Tax information specific to carrying on a business at or from your home. This guide does not cover situations where you are not carrying on a business at or from your home, even though you may have an area of your home set aside for work or business activities. For more general business tax information, see Tax basics for small business (NAT 1908) and Income tax and deductions for small business (NAT 10710), available from or by phoning

2 Our commitment to you We are committed to providing you with advice and information you can rely on. We make every effort to ensure that our advice and information is correct. If you follow advice in this publication and it turns out to be incorrect, or it is misleading and you make a mistake as a result, we must still apply the law correctly. If that means you owe us money, we must ask you to pay it. However, we will not charge you a penalty or interest if you acted reasonably and in good faith. If you make an honest mistake when you try to follow our advice and you owe us money as a result, we will not charge you a penalty. However, we will ask you to pay the money, and we may also charge you interest. If correcting the mistake means we owe you money, we will pay it to you. We will also pay you any interest you are entitled to. You are protected under GST law if you have acted on any GST advice in this publication. If you have relied on GST advice in this publication and that advice later changes, you will not have to pay any extra GST for the period up to the date of the change. Similarly, you will not have to pay any penalty or interest. If you feel this publication does not fully cover your circumstances, please seek help from the Tax Office or a professional adviser. The information in this publication is current at July We regularly revise our publications to take account of any changes to the law, so make sure that you have the latest information. If you are unsure, you can check for a more recent version on our website at or contact us. about this guide This guide has been written specifically for people who choose to carry on a business at or from their home. It explains the main tax issues you need to be aware of if you are carrying on a home based business. It does not cover situations where you are not carrying on a business at or from your home, even though you may have an area of your home set aside for work or business activities. When we refer to you or your business in this guide we are referring to you as a small business entity, for example, a sole trader, a partnership, a company or a trust that conducts a business at or from your home. We use examples of four businesses throughout the guide to show the different ways people can operate a home based business, and the tax implications. Commonwealth of Australia 2006 This work is copyright. Apart from any use as permitted under the Copyright Act 1968, no part may be reproduced by any process without prior written permission from the Commonwealth. Requests and inquiries concerning reproduction and rights should be addressed to the Commonwealth Copyright Administration, Attorney General s Department, Robert Garran Offices, National Circuit, Barton ACT 2600 or posted at published by Australian Taxation Office Canberra June 2006 JS 5283

3 contents How to access Tax Office publications 2 Tax matters you need to consider 3 01 Introduction 5 What is a home based business? 5 Are you actually carrying on a business? 6 Is your business structure right for you? 6 Registering your business 6 What if you stop carrying on your business? 8 02 What are your tax obligations? 9 Your tax obligations 9 Should you join the simplified tax system? What expenses can you claim? 14 Does the area set aside have the character of a place of business? 14 Expenses related to the area of your home used for business 14 Motor vehicle expenses 19 Other issues Useful products and services 20 DEFINITIONS 21 More information 22 INDEX CGT IMPLICATIONS OF CARRYING ON A HOME BASED BUSINESS 11 Do you have to pay capital gains tax when you sell your home? 11 How to work out how much of your capital gain is taxable 11 Did you first use your home for business after 20 August 1996? 12 Records you need to keep 13 Small business CGT concessions 13 carrying on a business at or from your home 1

4 how to access tax office publications The Tax Office produces a range of publications designed to help small business. Relevant publications are listed in the More information boxes throughout this guide. To view publications The quickest way to access our publications (including forms) is by going to our website at and typing the name of the publication into the search box. To have publications sent to you Ordering online You can order our booklets, forms and other publications from your computer. Go to and follow the links from Booklets and publications to Online ordering. Ordering by phone There are two ways you can do this: 1 Using our automated service: n for businesses (if you have an ABN), or n for individuals (if you don t yet have an ABN). This automated service is available 24 hours a day, 7 days a week. It is for people who know the name of the publication they want to order and have no other queries. Businesses have to state: an ABN and the name of a contact person (not the business name) we need this for delivery purposes, and the name of the publication and number of copies required. Individuals have to state: the name of the publication and number of copies required, and a name and address for delivery purposes. 2 Using our publications ordering service on An operator-assisted ordering service is available 8.00am to 6.00pm weekdays (closed on weekends and public holidays). An automated publications ordering service is also available on this number 24 hours a day, 7 days a week, for people who know the name of the publication and have no other queries. How to access other useful products Item Description How to access Business A secure website that is available 24 hours a day, 7 days a week. Portal e-record Record keeping evaluation tool You can use the portal to: n lodge activity statements online n revise previous activity statements n check your tax accounts n view and update most of your business registration details, and n send us secure messages. You may be eligible for a two-week deferral if you use the Business Portal to lodge and pay your activity statement online (subject to terms and conditions). Our record keeping software designed to help small businesses keep good business records. It is available in both PC and Macintosh versions and is suitable for businesses that operate on a cash basis of accounting, currently keep paper records and have one bank account. Helps you understand what records you need to keep and evaluate whether your record keeping practices are adequate. It provides a list of records tailored specifically for your business, a report on how well your business is keeping its records, and suggested improvements where appropriate. You can use it for an existing business or if you are thinking about starting a business. You will need an ABN, internet access and minimum computer requirements, and a free ATO digital certificate to identify yourself. For more information visit You can download a copy from or phone to order a CD-ROM. You can download a free copy from e-tax Allows you to complete your Tax return for individuals electronically. You can download a copy from Product register Electronic calculators A reliable source of information on commercially available tax-related software. The software listed on the register meets Tax Office requirements and will help you meet your tax obligations. We also have a range of electronic calculators such as the tax withheld calculator, fringe benefits tax (FBT) car calculator and home office expenses calculator. You can access the register at You can access the calculators at 2 Carrying on a business at or from your home

5 TAX MATTERS YOU NEED TO CONSIDER If you are carrying on a business at or from your home, or are considering doing so, here are the main things you need to find out about for tax purposes. Hobby or business? Business structure Registering your business Tax obligations Capital gains tax Deductions Make sure that you are indeed carrying on a business and that your activities are more than just a hobby. This has important income tax implications. Make sure that the business structure you choose (or already use) is the best one for your home based business, and that you are aware of the tax obligations related to the structure. The main business structures are sole trader, partnership, company or trust. Find out whether your business needs to be registered for any of the following tax obligations: n goods and services tax (GST) n pay as you go (PAYG) withholding, and n fringe benefits tax. You may need to apply for a tax file number and an Australian business number (ABN). There may also be state and local government regulations you need to consider. As with any business, you ll have a number of tax obligations for a home based business. Find out which ones apply to your business. Find out about the possible capital gains tax implications of carrying on a business at or from your home. You may need to keep special records to calculate the capital gain. You can generally deduct expenses associated with running your business. Make sure you know what expenses you can claim. See page 6 See page 6 See page 6 See page 9 See page 11 See page 14 carrying on a business at or from your home 3

6 4 Carrying on a business at or from your home

7 introduction 01 An increasing number of Australians are choosing to run a business at or from their home. Such businesses are known as home based businesses. In some instances, the business will be a person s main source of income, while other people are employees who also run a home based business. What is a home based business? A home based business is one where: The business is operated AT home or The business is operated from home That is, most of the work of the business is carried out at the home of the operator. An example would be a dressmaker who does all her work at home, with clients coming to her home for fittings. That is, the business does not own or rent any premises other than the home of the operator. An example would be a tiler who does most of his work on clients premises but does not have any other business premises. Home based businesses cover a range of activities. Here are some examples. Business activity Accommodation, cafes and restaurants Agriculture, forestry and fishing Communication services Construction Cultural and recreational services Education Finance and insurance Health and community services Personal and other services Property and business services Transport and storage Wholesale and retail trade Examples Bed and breakfast operator, caterer, campground owner Shearer, market gardener Mail service provider, web designer, desktop publisher, graphic designer Bricklayer, plumber, carpenter, tiler, fencer, electrician, builder, engineer, draftsperson, cabinetmaker, woodworker Motion picture editor, sound recordist, artist, musician, piano tuner Tutor, music teacher Financial adviser, consultant, accountant, bookkeeper, insurance broker Dietitian, chiropractor, counsellor, physiotherapist, psychologist, massage therapist Personal trainer, photographer, hairdresser, beautician, child minder, dressmaker, event manager, cake decorator, jeweller, pet groomer Plant hire or leasing operator, architect, surveyor, interior decorator, house painter, cleaner, gardener, service and repair operator, signwriter, tree lopper Courier, freight carrier, removalist Fresh fruit wholesaler, confectionery supplier, florist, watchmaker, partyplan operator, telemarketer This guide looks only at the tax issues that are specific to carrying on a home based business as defined above. carrying on a business at or from your home 5

8 01 INTRODUCTION DO YOU WORK AT HOME BUT DON T CARRY ON A HOME BASED BUSINESS? If you are not carrying on a business at or from your home but do some work at home, see the following publications for what deductions you can claim: n Tax basics for small business (NAT 1908) n Taxation Ruling TR 93/30 Income tax: deductions for home office expenses n Practice Statement PS LA 2001/6 Home office expenses Are you actually carrying on a business? If you re setting up a home based business or already operating one, make sure that you are indeed carrying on a business and that your activities are more than just a hobby. This is important because if your activities constitute a hobby rather than a business: n you don t include income earned from these activities in your assessable income, and n you can t claim a deduction for any expenses associated with the activities. More information n Tax basics for small business (NAT 1908) Is your business structure right for you? Make sure that the business structure you choose (or already use) is the best one for your home based business. This is important because different structures have different responsibilities and are taxed differently. The business structures commonly used by small businesses in Australia are: n sole trader n partnership n trust, or n company. If you re not sure which structure to choose, talk to an accountant, tax agent, solicitor or other adviser. More information n Tax basics for small business (NAT 1908) Registering your business Your business may need to be registered for a number of different tax obligations, including: n goods and services tax (GST) n pay as you go (PAYG) withholding, and n fringe benefits tax. You may need a tax file number and an Australian business number (ABN). You may also need special licences or state or local government approvals for your home based business. For example, you may need to register a business name or meet certain local government by laws. EXAMPLES: Setting up and registering a home based business Alex (sole trader) Alex is an electrician who uses his home as his base for his electrical business. He has finished paying off his home and now owns it outright. Alex has converted his garage to a workshop, but does most of his electrical work on clients premises. His workshop covers about 10% of the floor area of his home. He has a van that he uses to carry his tools and electrical equipment from job to job. Alex has many different clients and charges them an hourly rate. His business is listed in the Yellow pages and he advertises in his local paper. When setting up his home based business, Alex decided to operate as a sole trader. This means he uses his individual tax file number for his business and reports his business income in the supplementary section of his individual income tax return. Alex registered for an ABN to register for GST and he also needs to quote an ABN when dealing with other businesses such as his suppliers. While he didn t have to register for GST because his expected annual turnover is less than $50,000, he chose to register because he prefers to charge GST and claim GST credits. Alex is not registered for PAYG withholding or fringe benefits tax as he doesn t have employees. However, he would need to register for PAYG withholding if he makes a payment to a supplier that doesn t quote an ABN. Independent contractors are generally responsible for their own superannuation. Alex should refer to Superannuation guarantee for contractors (NAT 6402) at to help determine whether he is an employee or contactor for superannuation guarantee purposes. 6 Carrying on a business at or from your home

9 01 INTRODUCTION Pam (company) Pam is a freelance technical writer whose company runs her business from her home. She is paying off her home. Pam has converted a bedroom into an office, where she does most of the work for her company. The office covers 9% of the floor area of her home. Pam has many different clients, and the company charges them an hourly rate. The company s business is listed in the Yellow pages and also has a website. When setting up the business, Pam decided to run it through a company. This means she had to get a tax file number for the company and has to lodge a company tax return each year, in addition to her individual tax return. Pam registered her company for an ABN, and also for GST as she expected it to have an annual turnover of at least $50,000. The company is required to be registered for PAYG withholding as it pays salary and wages to Pam, who is an employee of the company. It may also register for fringe benefits tax as it provides Pam with private use of a company car. If Pam is entitled to payment for her duties as a director of the business, such as salary and wages or directors fees, then generally her company should pay superannuation contributions to a complying superannuation fund or retirement savings account on her behalf. The company must also allow Pam to choose which fund her contributions are paid into. Pam should refer to Superannuation guarantee a guide for employers (NAT 1987) at for more information. Vinh and Barbara (partnership) Vinh and Barbara rent a home, from where they sell musical instruments over the internet. As the instruments are shipped directly from various wholesalers to their clients, Vinh and Barbara don t actually handle the goods and therefore don t need any storage space. They do all their work on a computer set up in a corner of their living room. Vinh and Barbara advertise their business in the Yellow pages and on their website. When setting up their business, Vinh and Barbara decided to work as a partnership. This means they had to get a tax file number for their partnership. While they have to lodge a separate income tax return to report the partnership s income, they each pay tax on their share of income from the partnership through their individual tax returns. Vinh and Barbara registered their partnership for an ABN, and also for GST as they knew they would have an annual turnover of at least $50,000. However, they did not need to register the partnership for PAYG withholding or fringe benefits tax as it does not have any employees. Vinh and Barbara are responsible for their own superannuation arrangements as they are partners in a partnership. They should refer to Superannuation guarantee a guide for employers (NAT 1987) at for more information. Olga (sole trader) Olga runs a small florist business from her home, arranging posies for weddings and other formal functions. She is paying off her home. The business was once a hobby but has grown as Olga has been able to devote more time to it. She does not have an area set aside for her work but does most of the work on the kitchen table when her children are at school. Olga advertises in her local paper but gets most of her business by word of mouth. Olga operates as a sole trader, so she uses her individual tax file number and reports her business income in the supplementary section of her individual income tax return. She registered for an ABN, but as she has an annual turnover of only about $25,000 from her floral work, she did not register for GST. She may need to do so if her annual turnover increases to at least $50,000 in the future. She does not have any employees and therefore does not need to register for PAYG withholding or fringe benefits tax. Independent contractors are generally responsible for their own superannuation. Olga should refer to Superannuation guarantee for contractors (NAT 6402) at to help determine whether she is an employee or contactor for superannuation guarantee purposes. More information n Tax basics for small business (NAT 1908) n Visit business.gov.au carrying on a business at or from your home 7

10 01 INTRODUCTION What if you stop carrying on your business? There are a number of tax matters you may need to attend to if you cease to operate a business, or sell the business. These may include: n cancelling your ABN and other registrations n making certain GST adjustments on your final activity statement, and n lodging final tax returns. You should also check whether your state or territory government has any special requirements. More information For more information about cancelling tax registrations see: n What you need to tell the Tax Office when your business ceases (NAT 11108) n GST and disposal of capital assets (NAT 7682) Or you can phone and we will help you work through what you need to do. For more information about government regulations concerning company and business name deregistration, employee payments, and specific state or territory requirements, visit business.gov.au 8 Carrying on a business at or from your home

11 WHAT ARE YOUR TAX OBLIGATIONS? 02 As with any business, you ll have a number of tax obligations for a home based business. Use the following list to work out what obligations you have and whether you need more information about a particular obligation. DEALING WITH THE TAX OFFICE ONLINE You may be able to do a lot of your dealings with the Tax Office online, for example, register, and lodge your activity statements. For more information about how to do this, phone Your tax obligations Income tax Capital gains tax If you have taxable income, you have to pay income tax. Your taxable income is your assessable income less any allowable deductions. You may have to pay capital gains tax if you dispose of any capital assets and make a capital gain. Capital gains are included in your annual income tax return. Make sure you re aware of the capital gains tax consequences of using part of your home to run a business. GST Fringe benefits tax PAYG withholding Superannuation Record keeping Reporting and paying If you re registered (or required to be registered) for GST and make taxable sales of goods and services, you are liable to pay to the Tax Office one-eleventh of the price of most of the goods and services you sell. You can generally claim a credit for the GST included in the price of goods and services you purchase for use in your business. If you provide fringe benefits to employees, including working directors, you may have to pay fringe benefits tax. You have to withhold amounts from payments you make to employees and company directors, and payments to suppliers who don t quote their ABN. You have to pay superannuation contributions for most employees, including working company directors. You also have to offer eligible employees a choice of which fund they want their superannuation paid into. You are required to keep records that explain all your business transactions. Records must be in English (or in a form that can be converted into English). If your records are not in a written form (for example, in an electronic form such as a computer system), they must be in a form that is readily accessible and easily converted to English. You must keep your business records for at least five years. Generally, as a home based business, you report and pay your PAYG instalments and amounts withheld, GST and fringe benefits tax on a monthly or quarterly activity statement. Small businesses with an annual turnover of less than $50,000 can voluntarily register for GST and choose to calculate and report GST annually. This option is not available for taxi operators. You also have to lodge an annual income tax return and may have to lodge a fringe benefits tax return. Depending on the structure you choose for your business, you may have to lodge an annual trust, partnership or company return. For an overview of employer obligations visit carrying on a business at or from your home 9

12 02 WHAT ARE YOUR TAX OBLIGATIONS? Should you join the simplified tax system? The simplified tax system is an alternative method of determining taxable income for eligible small businesses with straightforward financial affairs. It allows you to use: n simplified trading stock rules, whereby you have to conduct stocktakes and account for changes in the value of trading stock only in limited circumstances, and n simplified depreciation rules, whereby you can claim a deduction for most depreciating assets costing less than $1,000 each in the year you incur the expense. Most other depreciating assets are pooled and deducted at a rate of either 30% or 5%, depending on their effective life. Newly acquired assets are deducted at half the relevant pool rate in the first year, regardless of when they were acquired during that year. From 1 July 2005 you may also be eligible for a new tax offset known as the 25% entrepreneurs tax offset. This is a tax offset (rebate) of up to 25% of the income tax liability attributable to the business income of taxpayers in the simplified tax system who have an annual group turnover of less than $75,000. Further, a shorter period during which the Tax Office can review and adjust tax assessments for the and later income years now applies to most taxpayers in the simplified tax system. More information n The simplified tax system a guide for tax agents and small businesses (NAT 6459) n Tax basics for small business (NAT 1908) 10 Carrying on a business at or from your home

13 CGT IMPLICATIONS OF CARRYING 03 ON A HOME BASED BUSINESS If you carry on a home based business, you may have to pay capital gains tax (CGT) when you sell your home, even if: n you do not claim deductions for occupancy or running expenses (see page 14) n you have never claimed a deduction for any interest on money borrowed to buy your home n you owned your home outright before you started using any part of it to produce income n you have started a business from home but have not yet made a profit. Capital gains tax is the tax you pay on any capital gain you make, which is included in your annual income tax return. There is no separate tax on capital gains rather, it is a component of your income tax. You are taxed on your net capital gain at your marginal tax rate. Generally, you can ignore a capital gain or loss you make when you sell your main residence (also referred to as your home ). However, you may have to pay capital gains tax when you sell your home if you have used any part of it for business purposes. Here we explain the capital gains tax implications of using part of your home for business purposes while continuing to live in it. Do you have to pay capital gains tax when you sell your home? If you make a capital gain when you sell your home, you may have to pay tax on part of the gain if you: n acquired the home on or after 20 September 1985 n used part of the home to produce business income at some time during the period you owned it, and n would be entitled to deduct any interest you incurred on money borrowed to buy the home (that is, you satisfy the interest deductibility test). When are you entitled to deduct interest? If you run a business in part of your home, you are entitled to deduct part of the interest on money you borrowed to buy your home if: n you have set aside part of your home exclusively or almost exclusively as a place of business and it is clearly identifiable as such (see page 14). Examples would be a consultant s home office, a carpenter s workshop, a dressmaker s sewing room, and n you cannot readily adapt that part of the home for private or domestic use, for example, a graphic designer s office located within their home. In these situations, you would be entitled to deduct any interest you incurred on money borrowed to buy the home (that is, you satisfy the interest deductibility test). This means you would have to account for any capital gain made when you sell your home. You may satisfy the interest deductibility test even if you didn t borrow money to acquire your home you must apply the test on the assumption that you did borrow money to acquire the home. You also satisfy the test if you were entitled to claim a deduction for the interest, even if you didn t actually claim the deduction. If you first use your home to produce income in a way that satisfies the interest deductibility test after 20 August 1996, there is a special rule to work out the amount of your capital gain or loss (see the next page). How to work out how much of your capital gain is taxable The proportion of any capital gain or loss you take into account for tax purposes is a reasonable amount in light of the extent that you would be entitled to a deduction for interest. In most cases, this would reflect the proportion of the floor area of your home you have set aside for business and the period you use it for this purpose. Olga (see example on page 7) and Vinh and Barbara (see example on page 7) don t have to worry about the capital gains tax implications of carrying on a home based business. There may be capital gains tax implications for Pam (see example on page 7) if she charges her company rent for using her home. In Olga s case this is because she would not be entitled to deduct interest because she doesn t have an area set aside exclusively for her business. Vinh and Barbara don t have to worry because they are renting their home and therefore capital gains tax on their home is not an issue. Pam doesn t have to worry about the capital gains tax implications of carrying on a home based business as the home is used by her company to carry on the business, not by Pam. This means that Pam cannot claim any interest deduction. However, if the company pays rent to Pam for the use of her home, Pam may have to work out a capital gain on the sale of her home (see the example on the next page). carrying on a business at or from your home 11

14 03 CGT IMPLICATIONS OF CARRYING ON A HOME BASED BUSINESS EXAMPLE: Using part of your home for business for part of the time you own it For the purposes of this example, assume that Alex purchased his home for $250,000 on 1 January 1991 and started operating his home based electrical business on 1 January Even though he owned his home outright before he started his business, he may have to pay capital gains tax on the part of the home he used for his business (that is, his garage) if he sells his house. This is because he would have been eligible to claim a deduction for interest on money he borrowed to buy the home. Alex has worked out that his workshop covers 10% of the floor area of his home. For example, if Alex had settled the contract for the sale of his home on 31 December 2002 for $330,000, he would work out his capital gain as follows: Capital gain x percentage of floor area not used as main residence x percentage of period of ownership when that part of the home was not used as main residence = capital gain $80,000 x 10% x 75% = $6,000 If Alex did not choose to work out his capital gain using the indexation method, he could discount the capital gain by 50%, after first applying any available capital losses against the capital gain. Did you first use your home for business after 20 August 1996? If you start using your home for business purposes (in a way that would satisfy the interest deductibility test) for the first time after 20 August 1996, there is a special rule for working out your capital gain or loss. Under this rule, you are taken to have acquired your home at its market value at the time you first use it for business purposes if all of the following apply: n you acquired the home on or after 20 September 1985 n you first used it for business purposes after 20 August 1996 n you would get only a part exemption because the home was used to produce assessable income during the period you owned it, and n you would have been exempt from paying capital gains tax if you had sold the home immediately before you first used it for business purposes. EXAMPLE: Home first used to produce income after 20 August 1996 Pam purchased her home on 1 November 1995 for $280,000 and her company started operating its business from her home and paying rent to Pam from 1 November The market value of her home at that time was $300,000. Even though she has never claimed a deduction for interest on money she borrowed to buy the house, Pam may have to work out a capital gain on the part of the home she rented to her company to enable it to carry on the business (that is, the office, which covers 9% of the floor area of the house) if she sells the house. This is because she would have been eligible to claim a deduction for mortgage interest. Because she first used her home to produce (rental) income after 20 August 1996, Pam can use a special rule to work out her capital gain. For example, if Pam had settled the contract on the sale of her home on 31 December 1998 for $330,000, she would work out her capital gain as follows: Percentage of x (proceeds cost base) = capital gain business use 9% x ($330,000 $300,000) = $2,700 If Pam did not choose to work out her capital gain using the indexation method, she could discount the capital gain by 50%, after first applying any available capital losses against the capital gain. 12 Carrying on a business at or from your home

15 03 CGT IMPLICATIONS OF CARRYING ON A HOME BASED BUSINESS Records you need to keep It is important to keep records that will allow you to easily calculate any capital gains tax if you sell your home. The main records you need are: n when your home based business started (this may not be straightforward if you had a home based hobby that became a business) n the proportion of the floor space of your home dedicated to earning income, and a record of any changes (for example, extensions to your home, extension of office space), and n the value of your house when you started business. If you don t have this, you will need to get a retrospective valuation. Sometimes it is easy to decide when you started your business, for example, the date you started production or the date your shop opened. But this is not always clear. You may want to record milestones in a diary to enable you and your tax adviser to establish a clear or notional start date for your business. For example: n 18 September 2004 set up business bank account n 19 September 2004 obtained an ABN. Getting a valuation on your home You generally use the purchase price of your home as your cost base when working out your capital gain. However, if you start carrying on a home based business after 20 August 1996 but purchased your home before that date, you may be able to use the market value of your home at the time you first used it for business purposes (rather than the purchase price) to work out your capital gain. Thus it s important to know the market value of your home at the time you start carrying on a home based business. If you don t know the market value of your home at the time you started carrying on your home based business, you will need to get a retrospective valuation to be able to work out your capital gain. Where the market value of your home needs to be determined, you can: n contact a real estate valuer to get a valuation you will find them listed in the Yellow pages, or n work out your own valuation based on reasonably objective and supportable data. When you sell your home, remember to include the capital gain amount in your income tax return for that year. EXAMPLE: Getting a valuation Frank owns a unit in a block of 10 units and needs to obtain its market value for capital gains tax purposes. He chooses not to approach a qualified valuer. A valuation based on sales of similar units in that block of units in recent times would be acceptable as it is based on reasonably objective and supportable data. The Tax Office may challenge valuations where appropriate. Small business CGT concessions If you have a capital gain because you use your home for business purposes, you may be able to apply one or more of the small business CGT concessions to reduce your capital gain. In order to apply the concessions, you must satisfy certain basic conditions. More information n Main residence exemption the effect of using your home to produce income (NAT 10255) n Guide to capital gains tax (NAT 4151) n Guide to capital gains tax concessions for small business (NAT 8384) carrying on a business at or from your home 13

16 04 what EXPENSES CAN YOU CLAIM? A home based business is generally entitled to claim similar expenses to a business that is not home based. While you can claim everyday running expenses in the year you incur them, you can claim other expenses, such as business related capital expenditure, over a number of years. You can t claim expenses such as domestic expenses and parking fines. More information n Income tax and deductions for small business (NAT 10710) In this section we look at two types of expenses that are more specific to carrying on a home based business: n expenses related to the area of your home used for business, and n motor vehicle expenses between your home and other business locations. But it is important to first establish whether the area you have set aside qualifies as a place of business as this will determine what expenses you can claim. Does the area set aside have the character of a place of business? The area you have set aside must have the character of a place of business. While this will depend on your particular circumstances, an area of your home is likely to have the character of a place of business if it is: n clearly identifiable as a place of business (for example, you have a sign identifying your business at the front of your house) n unsuitable for private or domestic purposes n used exclusively or almost exclusively for carrying on your business, or n used regularly by your clients. Examples could include a: n desktop publisher s home office n hairdresser s home salon n chiropractor s home consulting room n caterer s home kitchen n photographer s home studio n tutor s home classroom n carpenter s home workshop n area of home set aside for retail business n music teacher s home music room n dressmaker s home sewing and fitting room n home recording studio, and n bookkeeper s home office. If the area you have set aside qualifies as a place of business, you are entitled to deduct part of the interest payable on money you borrowed to buy your home. This means you satisfy the interest deductibility test and would have to pay capital gains tax on part of any capital gain you make when you sell your home (see page 11). Expenses related to the area of your home used for business As a general rule, expenses associated with your home are private and you can t claim a tax deduction for them. However, if you operate a business at or from your home, you may be able to claim a deduction for some of the expenses relating to the area you use for business purposes. These expenses are divided into: n occupancy expenses, and n running expenses. Occupancy expenses are expenses related to your ownership, rental or use of the home and are not incurred because of your income earning activities. In other words, you would have these expenses regardless of whether you were carrying on a home based business. Occupancy expenses include: n rent n mortgage interest n council rates, and n housing insurance premiums. If the personal services income rules apply to you, you will not be able to claim occupancy expenses such as rent, mortgage interest, rates and land tax. For more information see Tax basics for small business (NAT 1908). Running expenses are expenses related to using facilities within your home for business. Carrying on a business at or from your home means that these expenses may be higher than if you were not doing so. Running expenses include: n cost of using a room (such as electricity and gas costs for heating, cooling and lighting) n decline in value of plant and equipment (for example, desks, chairs, bookcases, computers, lathes, grinders) n decline in value of curtains, carpets, light fittings, etc. n cleaning costs n cost of repairs to furniture and furnishings, and n business phone costs. 14 Carrying on a business at or from your home

17 04 what EXPENSES can YOU CLAIM? What expenses can you claim? The expenses you can claim depend on the way you carry out your work at home. You have an area set aside exclusively for your business activities (eg, an office or workshop). You can claim occupancy and running expenses, provided the area set aside has the character of a place of business (see the previous page). or or You do not have an area set aside exclusively for your business (eg, you work in a corner of the lounge room or on the kitchen table). You can claim only running expenses. If you are eligible to claim only running expenses, you don t have to worry about capital gains tax if you sell your home. Capital gains tax applies only if you are eligible to also claim occupancy expenses. EXAMPLES Alex As Alex is carrying on a business from his home and has an area set aside exclusively for business purposes, and that area has the character of a place of business, he can claim both occupancy and running expenses. Alex has worked out that his workshop covers 10% of the floor area of his home, so he can claim deductions for 10% of his costs for gas, electricity, insurance premiums and council rates. If his work related gas and electricity costs are more than 10% of his total gas and electricity costs, he may be able to use special rules to work out how much he can claim (see page 17). If he had a mortgage, he could also claim 10% of the mortgage interest. Alex has a mobile phone that he uses exclusively for business calls but he also uses his home phone for some business calls. Alex can claim the cost of all his mobile calls. Based on a review of his itemised home phone bills, Alex estimates that 10% of calls from his house are for business purposes. So he claims 10% of the total call costs and line rental fees for his home phone. Alex also claims deductions for the decline in value of depreciating business equipment in his workshop. Alex can use the special rules available to work out his deductions (see page 17) or claim based on his actual expenditure. Vinh and Barbara While Vinh and Barbara are carrying on a business from their home, they do not have an area set aside exclusively for their business and therefore cannot claim occupancy expenses such as their rental payments. However, they can claim running expenses associated with carrying on their home based business, such as phone, internet, gas and electricity, and also depreciation costs on their computer. Vinh and Barbara have a separate phone line installed for their business so can claim a deduction for their total phone rental and call costs (but not for the installation). They also estimate that in producing their business income they incur additional electricity and gas costs. To work this out, they keep a diary for a four week period to establish a pattern of business use for the entire year. They then use this pattern to calculate the gas and electricity costs they can claim. As Vinh and Barbara use the computer solely for their business, they can claim decline in value of the computer. They can also claim the cost of their internet connection. Note that Vinh and Barbara cannot claim gas and electricity costs for times when others are using the living room. Olga While Olga is carrying on a business at her home, she does not have an area set aside exclusively for her business and therefore cannot claim occupancy expenses such as mortgage interest and council rates. However, she can claim running expenses associated with carrying on her home based business, such as phone and gas and electricity. Based on a review of her itemised home phone bills, Olga estimates that 20% of calls from her house are for business purposes. So she claims 20% of the total call costs and line rental fees for her home phone. Olga also estimates that in producing her business income she incurs additional electricity and gas costs. To work this out, she records the hours she spends doing work related to her business when others are not using the kitchen and claims 26 cents an hour for these costs. Note that Olga cannot claim gas and electricity costs for times when others are using the kitchen. carrying on a business at or from your home 15

18 04 what EXPENSES can YOU CLAIM? How much can you claim? Rent, mortgage interest, insurance, council rates If eligible to claim occupancy expenses, you can claim the percentage of rent, mortgage interest, council rates and insurance that relates to the area you use as a place of business. A common method of working out how much to claim is to use the floor area (as a proportion of the floor area of your whole home). For example, if the floor area of your home office is 10% of the total area of your home, you could claim 10% of your rent or mortgage interest, council rates and insurance. Utilities (gas, electricity) These expenses must also be apportioned. If the business percentage is based on anything other than the floor area (for example, on actual electricity use) you will need to clearly document your claim to show how you arrived at the amount. Where you don t have an area of your home set aside exclusively for business, you can t claim on a floor area basis as this area is also used for non business purposes. In this case, you ll need to show how you arrived at the amount you re claiming for gas and electricity. You re allowed a deduction only where you incur additional running costs because of your business activities. For example, if you work in a room where other family members are watching television, you would probably not have additional heating costs as a result of that work activity. Furthermore, the business use of the home work area needs to be substantial and not merely incidental. For example, you couldn t claim 26 cents an hour simply because your fax machine is on 24 hours a day, 7 days a week, to receive business faxes. See the next page for special rules you may be able to use in working out how much you can claim. Phone If you use a phone exclusively for business, you can claim a deduction for the phone rental and calls, but not the cost of having the phone installed. This is because the installation cost is considered a capital expenditure. If you use a phone for both business and private calls, you can claim a deduction for business calls and part of the rental costs. You use the following formula to calculate the percentage of phone rental expenses you can claim: Number of business calls made and received x 100 Number of total calls You can identify business calls from an itemised phone account. If you don t have an itemised account, you can keep a record for a representative four week period to establish a pattern of business calls for the entire year, provided you have a regular pattern of use throughout the year. Business plant and equipment You can claim a deduction over a number of years for the decline in value of depreciating assets used for business purposes. If you use plant and equipment solely for business purposes, you can claim the full amount of depreciation. But if you also use equipment (such as a computer, printer, photocopier, grinder, circular saw) for non business purposes, you have to reduce the depreciation deduction by an amount that reflects this non business use. You work out the amount of depreciation to claim as a deduction based on a bona fide estimate of the percentage of business use. You can base this estimate on a diary record of your business and non business use of equipment for a representative four week period. Your diary record needs to show the nature of each use of the equipment, whether it was for business or non business purposes, and the period of time it was used. From 1 July 2001 most deductions for depreciating assets are worked out under the general rules of the uniform capital allowance system. However, eligible taxpayers who elect to join the simplified tax system will generally calculate deductions for depreciating assets under the simplified tax system rules. See the next page for special rules you may be able to use in working out how much you can claim. Separating business and private expenses When claiming a deduction for expenses associated with carrying on a business at or from your home, you must be very careful to claim deductions only for those expenses related to producing income for your business. This means you ll often have to apportion expenses between business and private use to work out how much you can claim. EXAMPLE: Separating business and private expenses Alex bought a computer for $3,333 (including GST) to use in his business. However, his teenage son also uses the computer to play computer games. Alex estimates that his son uses the computer for 20% of the time and he uses it 80% of the time for his business. This means Alex can claim only 80% of the decline in value deduction for the computer. Because the computer is used partly for private purposes, Alex may also need to make an adjustment if he disposes of the computer. Note also that Alex can claim only 80% of the GST tax credit. More information n Guide to depreciating assets (NAT 1996) n The simplified tax system a guide for tax agents and small businesses (NAT 6459) n Record keeping for small business (NAT 3029) 16 Carrying on a business at or from your home

19 04 what EXPENSES can YOU CLAIM? Special rules for working out how much you can claim If you claim a deduction for expenses related to a home work area, you must be able to prove that you incurred the expenses. To ease compliance costs for individuals, the Tax Office accepts the following methods. Keep a diary Claim 26 cents an hour You can keep a diary that shows how you use your home work area for a representative four week period each financial year to establish a pattern of use for your home work area for the entire year. You can then use this pattern of use to calculate the expenses related to your home work area for the entire year, allowing for periods such as holidays or illnesses. If there is no regular pattern to how you use your home work area, you ll need to keep records of each time you use the area during the year, and the purpose you use it for. You have to keep a diary for each financial year as patterns of use are likely to fluctuate over two or more years. Instead of recording actual expenses for heating, cooling, lighting and depreciation of furniture (desks, tables, chairs, cabinets and shelves), you can claim a deduction of 26 cents an hour based on actual use or an established pattern of use. The rate of 26 cents an hour is based on average energy costs and the value of common furniture items used in home work areas. You have to separately calculate all other expenses related to your home work area, such as phone expenses and depreciation on computers or other equipment. Where you are entitled to claim a GST credit for a depreciating asset, the amount of the GST credit you can claim must be deducted from the asset s adjustable value before calculating the deduction for depreciation. The following example uses GST-exclusive figures. To help you work out your expenses relating to a home work area, we have developed an electronic home office expenses calculator. To access the calculator, visit EXAMPLE: Calculating deductions Option 1 (Actual running expenses): Pam s company has the following home office running expenses, including energy expenses which Pam has calculated using electricity authority hourly costs per appliance. The apportionment is based on her diary entries for four weeks, as shown in the following table. Item Calculation Deduction for this year Decline in value of desk Cost $1,333 over 20 years $66.65 $66.65 Decline in value of chair Cost $266 over 10 years $26.60 $26.60 Electricity for 100W lamp 1c per hour for 30 hours a week $14.40 $14.40 for 48 weeks Electricity for 60W ceiling light 0.7c per hour for 30 hours a week $10.08 $10.08 for 48 weeks Electricity for computer 1c per hour for 30 hours a week $14.40 $14.40 for 48 weeks Electricity for heating/cooling 9c per hour for 30 hours a week $ $ for 48 weeks Total deductible amount $ $ Deduction for future years (assuming similar use) carrying on a business at or from your home 17