If you make significant changes to your home to establish a place of business, then that portion of the home would be disqualified from the principal residence exemption.
What is the principal residence exemption you ask? The principal residence exemption is a benefit under the Income Tax Act that provides an exemption from tax on the capital gain realised when you sell the property that is your principal residence. The exemption applies for each year the property is designated as your principal residence.
If only a part of your home qualifies as your principal residence and you used the other part to earn income, then you have to split the selling price and adjusted cost base between the part you used for your principal residence and the part you used for other purposes.
The Canada Revenue Agency (“CRA”) treats the entire property as a principal residence in spite of the fact that you have used it for income producing purposes when all of the following conditions are met:
• The income producing use is ancillary to the main use of the property as a residence
• There is no structural change to the property
• No capital cost allowance is claimed on the property
So if you create a dedicated entrance to the basement for your business, as an example, the basement would likely be disqualified from the principal residence exemption and you would have to pay capital gains tax based on the value of basement when you sell your home.