Tax Benefits of Renting Out an ADU

Renting out an Accessory Dwelling Unit (ADU) in California can do more than just provide a steady stream of rental income—it can also unlock substantial tax benefits. From depreciation and mortgage interest deductions to maintenance write-offs, California homeowners who rent out a permitted ADU can reduce their taxable income significantly.

In this post, we’ll explore the most common and profitable tax deductions and credits associated with ADU rentals, what the IRS allows, and why permitting your ADU makes all the difference when it comes to claiming these benefits.

Is Rental Income from an ADU Taxable in California?

Yes—rental income from an ADU is considered taxable income by both the IRS and the California Franchise Tax Board. But the good news is that you're allowed to deduct a wide range of expenses related to maintaining and managing the rental property.

With proper record-keeping and a permitted ADU, you can claim deductions that offset the taxes owed on that rental income.

Top Tax Benefits of Renting Out an ADU

Here’s a breakdown of the most common and valuable tax deductions available to ADU landlords:

1. Depreciation

You can depreciate the cost of the ADU structure (not the land) over 27.5 years.
This is one of the largest tax benefits available and significantly lowers your annual taxable rental income.

2. Mortgage Interest

If you financed the ADU with a loan, the interest on that loan may be deductible proportionally based on rental use.

3. Property Taxes

A portion of your property taxes can be allocated to the rental unit and deducted accordingly.

4. Maintenance & Repairs

Costs for repairs, landscaping, pest control, and general maintenance on the ADU can be deducted in the year they’re incurred.

5. Utilities

If you pay for utilities (electricity, gas, water, internet), you can deduct the percentage that applies to your rental unit.

6. Insurance Premiums

The portion of your homeowner’s or landlord insurance that applies to the ADU is deductible.

7. Advertising & Management Fees

Any money spent on listing your ADU or hiring a property manager can be written off.

Bonus: Section 121 Exclusion (With Careful Planning)

If you live in your main home and later decide to sell, the IRS allows up to $250,000 ($500,000 for married couples) of capital gains to be excluded under Section 121. However, if your ADU was rented, you might have to recapture depreciation and allocate part of the gain as taxable.

Properly planning your sale with a tax advisor can help maximize your exclusion while complying with IRS rules.

Benefits of Building a Permitted ADU in California

A permitted ADU is key to unlocking full tax benefits. Here's why:

✅ Recognized by the IRS and local authorities
✅ Eligible for legal depreciation and write-offs
✅ Easier to prove expenses during an audit
✅ Boosts property value legally
✅ Protects you from code violations or back taxes

FAQ

Do I have to report all rental income from my ADU?

Yes, all rental income must be reported. However, with deductions, your taxable amount can be significantly reduced.

Can I deduct ADU construction costs?

ADU construction costs cannot be deducted immediately. Instead, the structure is depreciated over time.

What if I rent to family or friends at a discount?

If you're not charging fair market rent, you may not qualify for the same deductions. The IRS considers this a personal residence in many cases.

Can I write off the cost of furnishing my ADU?

Yes, if you’re renting the unit furnished, items like furniture, appliances, and decor can be depreciated or deducted.

Do I need a separate tax ID for my ADU rental?

Not necessarily. Most landlords use their personal Social Security number unless operating under a legal business entity.