Does Adding an ADU Increase Property Taxes?

How is Property Tax Calculated for an ADU in California?

To understand how ADU construction will impact property taxes, it is first important to understand how taxes are accessed in the state of California.

While many states calculate property taxes based on market value and reassess taxes on a semi-annual basis, Southern California calculates taxes using a bill called Prop 13, which was passed in 1978 in an attempt to keep real estate taxes low.

Prop 13 states that property taxes are calculated based on the selling price of the home, rather than the home’s current market value. Annual property tax increases following the sale of the home are capped at 2% of the home’s last sale price, not the current market value, and property tax assessments can only happen at the next point of sale.

So if you bought your home in 2015, your home’s current property taxes are determined based on what you paid in 2015, with a ~2% annual increase factored in.

But what if you build an ADU on your property? Will that trigger a reassessment of your existing home? No! The value of an ADU is added to the original purchase price of your existing home, and the value of your ADU is determined based on your construction costs. So if you bought your home back in 2015 for $500,000 and spent $100,000 building an ADU on your property, your home’s current value would be $600,000, and your property taxes would be determined based on that. Your primary residence will not be reassessed at the market rate. This type of assessment is what’s known as a blended assessment.

Prop 13 safeguards California homeowners by basing property tax increases on construction costs rather than fluctuating market values.

Factors That Determine the Tax Impact of Your ADU

Given that an ADU’s value is determined based on construction cost and not market value, lessening the tax impact of your ADU comes down to keeping construction costs as low as possible and opting for certain ADU types, where possible.

Cost of construction

When it comes to saving money on your ADU construction, there are two line items to consider: materials and labor.

The building materials you choose for your home can drastically affect its final assessed value, and an experienced ADU building partner can help you make smart swaps that will ultimately save you money on your property taxes now and for years to come. For example, they may suggest luxury vinyl tile for the entryway that gives the appearance and durability of real marble tile without the cost, saving you money.

Labor is the other line item to look out for when starting your ADU construction journey. In fact, labor can account for 40-50% of your total construction cost. That’s why it’s important to get quotes from multiple builders and to look for builders that specialize in ADUs as opposed to general residential construction.

If you are curious about what construction costs might look like for your specific build, you can use our cost calculator.

Choose practical, cost-efficient materials for your ADU to reduce its assessed value, lowering the long-term property tax impact.

Size and Scope of the ADU

Of course, the overall square footage of your ADU will play a role in your construction costs, as larger ADUs almost always cost more to build than smaller ADUs, which will then have a greater impact on your property taxes.

However, the type of ADU you choose to build can also play a role when it comes to your property taxes, either minimizing the impact or increasing it.

Garage Conversions

Garages that are converted into an ADU often have the least impact on your property taxes. This is because garage conversions are typically the most cost-effective model, especially when it comes to detached ADUs, as the structure itself already exists. This mitigates the costs that come from excavation, foundation work, framing, etc. Given that ADU tax impact is determined by construction costs, garage conversions typically have the lowest impact, especially compared to standard detached ADUs, which we’ll get into next.

Know, though, that to be considered a true ADU, a garage conversion must contain both a kitchenette and a bathroom. If the garage does not have one of these two things, it is not considered an ADU, and its value will be determined differently.

Detached ADUs

If garage conversions are some of the most cost-effective ADUs to build, detached ADUs are the least and can lead to a more significant tax increase.

Detached ADUs are new builds, meaning the construction costs include site assessment, excavation, foundation work, and framing, all of which increase the overall project budget.

Local Regulations

While Prop 13 governs the way property taxes throughout the state are assessed, regulations pertaining to ADU construction differ between municipalities, so it’s important to understand what your local regulations are before beginning any ADU project.

When Does the ADU's Value Get Added to Property Taxes?

Given that ADU value is determined by construction cost, it is added to your property taxes at the completion of the project, when final costs can be evaluated. After your new tax rate is determined, your property taxes will continue to increase at ~2% every year.

Reassessments for ADUs follow the same guidelines as the main residence, meaning your ADU will only be reassessed following a sale. If you choose to build more additional dwellings in the future, though, this will trigger another blended reassessment, as will making significant improvements to property, like additions to property.

Your ADU’s value is added to your property taxes after construction is complete, giving you full transparency on budget implications.

How to Minimize the Tax Impact of Your ADU

Hiring an experienced ADU contractor is the #1 thing you can do to minimize the tax impact of your ADU. There are a few reasons for this.

First, an experienced ADU contractor will know how to keep a project on time and on budget. When construction costs balloon due to contractor inexperience, so do your final property taxes.

An experienced ADU contractor will also help you narrow in on what luxuries are necessary to add during the initial phase of the build and which can wait until after assessment. And as we said earlier, they can also help you choose mid-range materials, when possible, that strike the right balance between quality and cost, getting you everything you are looking for without busting the budget.

Incorporate smart design choices like affordable fixtures that blend style and functionality to keep construction costs—and taxes—manageable.

What Are the Benefits of Adding an ADU Despite Property Tax Increases?

Though ADUs do come with an increase in property tax, most homeowners we work with find that the benefits of building an ADU far outweigh these added monthly costs.

Passive Rental Income

Especially in California’s competitive rental market, ADUs can provide homeowners with a significant rental income potential that far outpaces the increase they see in their property taxes. In San Diego County, for example, the average rent is just over $2,000 per month.

Long-Term Investment

While ADU taxes aren’t determined based on the market value of your home, make no mistake that building an ADU does increase the market value of your home.
Prop 13 allows you to enjoy minimal tax impact while you’re living on the property, but also enjoy the tremendous growth of property value when you ultimately go to sell.

Multigenerational Living

If you are building an ADU to serve as an in-law suite, you not only keep aging parents close and enjoy multigenerational living, but you can ultimately save money on expensive assisted living or care facilities.

ADUs provide a high ROI through passive rental income, which often surpasses the added tax burden.

How Will Building an ADU Affect Personal Taxes?

An ADU can affect your personal taxes if you use it as a rental unit, as the rent you receive each month will be added to your household income.

However, if you do rent out your ADU, you can also take advantage of depreciation, which allows you to reduce the value of your ADU each year to account for tenant for wear and tear. So while your personal tax rate may increase over time, depreciation allows you to lessen your property tax burden over time.

To better understand how building and renting an ADU might impact your income taxes, reach out to a tax professional.

Anticipate how final construction costs will impact property taxes and plan accordingly to stay within your financial goals.

Is Building an ADU Tax Deductible?

No, generally, building an ADU in and of itself is not considered tax deductible. However, when building an ADU, you can take advantage of tax incentives or tax benefits associated with particular elements of construction.

Adding solar to your ADU, for example, can make you eligible for a home electrification rebate, and installing certain energy-efficient appliances can make you eligible for appliance rebates.

Leverage rebates for energy-efficient upgrades like solar panels to offset construction expenses and maximize your investment.

How to Navigate ADU Tax Implications in California

No one wants to be surprised when it comes to property taxes, and the best way to avoid unwanted surprises is to consult with your local tax assessor or property planner before you build to understand how your specific ADU may ultimately affect your taxes.

An experienced ADU builder can also do this on your behalf, checking local regulations and zoning guidelines and helping you assess your own financial readiness before you break ground.

Work with professionals familiar with local regulations to ensure a smooth approval process and avoid unexpected tax complications.

Learn More About ADUs in San Diego with Better Place Design & Build

As we’ve been saying, experience matters, especially when it comes to ADU construction and tax impact.

At Better Place, we understand the logistics of ADU construction from every angle and how to create customized designs that not only meet local zoning laws and minimize tax impact but also fulfill all our client’s housing goals.

We’d love to hear what you’ve been dreaming of and how we can make that dream a reality. Get in touch any time for a free consultation.