Taxes and ADUs

Are you thinking about building an accessory dwelling unit (ADU) to generate rental income? Or, perhaps your ADU is going to be used to house your family members? The benefits of building an ADU are endless, but the one concern that many homeowners are concerned with are the added property taxes. Don't let taxes stop you from building an ADU.

In California, property taxes are typically 1% of the property’s assessed market value. The construction of your ADU will trigger a reassessment, but it will be a blended assessment. The ADU will be assessed by itself. So, its market value is will generally be assessed a 1% tax and added to your current tax bill (a blended rate). Over time, your tax rate may increase but is capped at 2% thanks to Prop 13. 

Let’s look at the math

Consider this example of how taxes could play out. If your ADU is valued at $100,000, your tax bill would only increase by $1,000 ($100,000 x 1% = $1,000). Over 12 months, the tax impact of building your ADU is only $83 per month. Compare that to the potential rent you may collect for your ADU. Whether you charge $1,200 or $2,200 per month for your ADU, it will be more than enough to justify the added property taxes. In fact, in this example, it’s 14 times more than enough! 

Protecting yourself plus some benefits 

Consider wrapping your ADU in an LLC. If a mishap were to happen with your ADU renter, you can rest assured knowing you and your assets (like your existing home on the property) can be protected. The benefits of running your new rental business under an LLC, aside from the protection, is being able to deduct all the startup costs (builder fees, permit fees, and other soft costs) as well as organizational expenses (all charges incurred to create the LLC entity). The maximum deduction is $5,000, which is reduced dollar-for-dollar by the amount over $50,000. Any remaining startup costs and organizational costs that are not immediately deducted may be amortized over 15 years. 

The cost of the ADU itself is allowed to be depreciated over 27.5 years, starting the month the ADU becomes available for rent. Explained differently, you can write off a huge expense (depreciation) as soon as your ADU is completely built and available to rent. Even if you don’t have a renter in the ADU, as long as the unit is made available (e.g., is listed ‘for rent’ online or in the local paper), then you get to recognize the depreciation expense. If your ADU cost is $100,000 and assuming it was available for rent January 1, the first year’s depreciation would be $3,485 ([$100,000 / 27.5 years] x [11.5 / 12] = $3,485.85). 

The business income is recorded directly on your tax return, which means you’re getting the legal protections of an LLC and writing off almost all the expenses (including depreciation) and then only having to pay taxes once on the income. All of your rental income and expenses will be captured on your Schedule E, which flows to page 1 of your tax return*. 

A lot to think about

There is a lot to consider about your accessory dwelling unit. There is much information out there, and yes, you could do this by yourself (but should you?). Things to think about are: 

• What will it cost to construct? 
• How are you going to finance the construction costs? 
• What company, architect or plans are you going to use? 
• How much time will be required to plan and construct the ADU? 
• What are all of the added expenses to pull permits? 
• What inspections involved?

Want the answers to all of your questions and pre-made plans for the perfect ADU? OneStop ADU has 6 pre-designed plans available in 3 exterior styles—Contemporary, Craftsman and Spanish/Mediterranean. We did all the leg work and have sourced interior and exterior finish selections for each style creating a cohesive designer look. Since plans are already created, we save you money, time and the hassle so that your permit application can be submitted to the city more quickly. Remember, ADUs are not only a great way to generate additional income every month, but it’s also a way to create immediate equity. 

If you are considering an ADU and have more questions, or would like to schedule an in-person meeting and a complimentary feasibility study of your property, contact us by phone at 858-437-8476, or email at info@onestopadu.com. 

*This content has been prepared for informational purposes only, and is not intended to provide, tax, legal, or accounting advice. Please consult your own tax, legal, and accounting advisors before engaging in any transaction.