ADU Tax Credit: What You Need to Know

What is an ADU Tax Credit?

A tax credit is a dollar-for-dollar reduction in the amount of taxes you owe for the year you’re filing. An ADU tax credit is a dollar-for-dollar reduction in taxes based on construction costs.

While some states like Massachusetts and Vermont offer grant and rebate programs, none offer this type of ADU tax credit. California’s SB 1164, which passed in 2022, does provide legislation surrounding ADU property tax rates that ultimately benefit homeowners. It states that building an ADU on your property doesn’t trigger a full property reassessment but rather a blended assessment, where the value of your secondary housing unit will be added to the previously assessed value of your existing home.

To learn more about SB 1164 and property tax assessments for ADUs, you can read our separate post here.

While you may not receive a direct tax credit for ADU construction, homeowners can claim deductions on costs related to rentals or home office use, especially utilities and maintenance.

Who Qualifies for the ADU Tax Credit in California?

While there are no state-wide tax credits, there are certain write-offs and incentives that homeowners who build an ADU can qualify for. The first is renewable energy. As with single-family homes, adding solar panels and energy-efficient appliances to your secondary unit can lead to tax rebates. The current federal rebate is as much as 30%, which can both reduce your federal tax liability and increase your annual refund.

You can also write off certain aspects of your ADU if you use it as a rental unit or a home office. Landlords renting out their ADU can write off certain expenses such as mortgage interest, maintenance fees, and cleaning fees. These write-offs will ultimately help to offset any impact an ADU and the rent it generates may have on your individual income taxes.

For those who own their own business and use their ADU as a home office, you can write off utility costs, insurance, and maintenance costs. The write-offs for home businesses are calculated based on square footage. This means that if your ADU accounts for 25% of your property’s total square footage, you can write off 25% of your property’s electricity bill, homeowner’s insurance, etc. A tax professional can help you make these calculations accurately.

Using your ADU as a rental property or home office can qualify you for tax deductions on utilities, insurance, and maintenance. Proper planning ensures you maximize these benefits while keeping property tax increases minimal.

How to Apply for the ADU Tax Credit

The best way to apply for any local ADU tax credits or incentives is to first contact your city government to learn more about them, then use an experienced ADU builder to ultimately manage the construction of your ADU. They’ll be familiar with any local incentives and can help design your ADU with these in mind.

For write-offs pertaining to rentals or home offices, a tax professional can help make sure you are taking advantage of all possible tax incentives. Know that in order to do so, though, you need to be able to provide receipts for any relevant expense, be it a repair bill, a cleaning fee, an insurance payment, or something else.

Working with an experienced ADU builder can help you maximize tax incentives and navigate city-specific rebates. Keeping receipts for expenses is key to claiming deductions.

How the ADU Tax Credit Impacts Property Taxes

ADUs typically do lead to additional property taxes, though the impact is often not as much as homeowners assume, especially because building an additional unit on your property doesn’t trigger a full property assessment but rather the blended assessment we mentioned earlier.

You can read more about ADUs and property taxes in our separate post here; know that ADU builders like Better Place often understand how construction costs ultimately impact your final property taxes and can help you keep these costs low while still ensuring you get all the features you need to get the most out of your extra space.

Once your ADU is built, understanding the tax deductions and credits available for maintenance, utilities, and rental income will help optimize your tax savings. Be sure to track all relevant expenses.

What is Tax Deductible with an ADU?

We mentioned earlier that certain tax deductions and incentives for single-family homes also apply to ADUs when it comes to the operational costs of a home office or rental property. This is especially true for the installation of solar and other energy-efficient appliances. It’s important to know, though, that to make the most of write-offs pertaining to a home office, an LLC is required. There are many things that you can deduct as a landlord if you’re renting out your ADU that are different from regular homeowners.

Sidenote: There are some initial costs associated with forming an LLC, even if you are the only employee, as well as some annual state fees. It’s highly recommended to form an LLC if you plan to rent out your unit, as this can help lower liability by directing it towards the LLC instead of yourself personally. Consult a tax professional to learn more.

For homeowners using their ADU as a rental property, it’s important to not only be aware of write-offs but also of how depreciation (as outlined by SB 1164) lessens your property tax impact over time. SB 1164 allows the value of the ADU to depreciate if it is used as a rental, to account for normal wear and tear. This means that your rental property taxation decreases over time as the ADU ages.

ADU construction costs are not directly tax-deductible, but rental expenses, home office use, and energy-efficient upgrades can qualify for tax deductions. Keeping accurate records is essential for maximizing benefits.

Better Place Design & Build: Your Partner in Maximizing ADU Benefits

No one understands the accessory dwelling unit landscape better than Better Place Design & Build. We help homeowners navigate all the trickiest parts of the ADU building process, from obtaining a building permit to minimizing their impact fees and their annual property taxes, ensuring a stress-free transformation of your single-family lot.

To learn more about what’s possible on your property and get an accurate estimate, reach out for a free consultation.