ADU Tax Credit in California: What Homeowners Actually Qualify For

TL;DR: ADU Tax Credit

• There is no direct California ADU tax credit for construction costs, but certain federal energy credits and tax deductions may apply.
• Homeowners can claim deductions if the ADU is used as a rental property or qualified home office.
• Energy-efficient upgrades such as solar panels may qualify for a federal tax credit of up to 30%.
• Adding an ADU increases property taxes through a blended assessment, not a full reassessment.
• Rental ADUs may qualify for annual depreciation deductions over 27.5 years.
• This article explains available credits, rental deductions, property tax impact, and common misconceptions.

ADU tax credit is a commonly searched term referring to potential tax benefits tied to building or using an accessory dwelling unit. While California does not offer a direct construction tax credit, homeowners may qualify for federal energy credits, rental property deductions, or home office write-offs depending on how the ADU is used. Most tax benefits are claimed annually when filing income taxes and require proper documentation.

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.

ADU Tax Credit vs. ADU Tax Deduction: What’s the Difference?

Many homeowners use the terms “tax credit” and “tax deduction” interchangeably, but they are not the same. A tax credit directly reduces the amount of taxes you owe, while a tax deduction reduces your taxable income.

Example

• If you qualify for a $5,000 tax credit, your tax bill drops by $5,000.
• If you qualify for a $5,000 deduction and you’re in a 24% tax bracket, you save $1,200.

Quick Answers

• Is there a California ADU tax credit for construction? No, California does not offer a direct construction tax credit for ADUs.
• Are rental write-offs considered tax credits? No, they are tax deductions.
• Which is better: a credit or a deduction? A credit typically provides a larger financial benefit because it directly reduces taxes owed.

Quick Comparison

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.

Do Solar Panels or Energy Upgrades Qualify for an ADU Tax Credit?

While ADU construction itself is not eligible for a tax credit, certain energy-efficient upgrades may qualify for federal incentives.

The federal Residential Clean Energy Credit currently allows eligible homeowners to claim up to 30% of qualified solar installation costs, subject to IRS guidelines. Federal clean energy credits remain in effect under current IRS guidelines, but percentage amounts and eligibility rules are scheduled to phase down in future years.

Potential Eligible Upgrades

• Solar panels
• Battery storage systems
• Energy-efficient HVAC systems
• Certain heat pumps

How It Works

1. Install qualifying energy equipment.
2. Retain invoices and certification documents.
3. Claim the credit when filing federal taxes.

Quick Answers

• Does the 30% credit apply to the whole ADU? No, only to eligible energy components.
• Is there a cap on the solar credit? The federal solar credit currently does not have a dollar cap for residential systems.
• Can landlords claim energy credits? Rules differ depending on whether the property is primary residence or rental; consult a tax professional.

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 ADU Rental Expenses Are Tax Deductible?

If you rent out your ADU, the IRS generally treats it as a rental property. This means you may deduct ordinary and necessary expenses related to generating rental income.

Common Deductible Rental Expenses

• Mortgage interest (portion tied to the ADU)
• Property taxes (ADU portion)
• Utilities
• Maintenance and repairs
• Insurance
• Property management fees
• Depreciation

High-Level Process

1. Track all ADU-related expenses throughout the year.
2. Separate personal vs. rental use expenses.
3. Report rental income and expenses on Schedule E.

Quick Answers

• Can I deduct the full mortgage payment? Only the portion attributable to the rental space.
• Can I deduct repairs? Yes, ordinary repairs are typically deductible in the year they occur.
• Are improvements deductible? Improvements are usually depreciated over time, not deducted immediately.
• Do I need an LLC to claim rental deductions? No, but many landlords form one for liability protection.

How Depreciation Works for a Rental ADU

If your ADU is used as a rental property, the structure itself may be depreciated over time.

Depreciation allows you to recover the cost of the building (not the land) over a set period, typically 27.5 years for residential rental property.

Example

If your ADU construction cost (excluding land) is $275,000:

• $275,000 ÷ 27.5 years = $10,000 per year in depreciation.

This reduces your taxable rental income annually.

Quick Answers

• Can I depreciate the full construction cost? Only the building portion, not land value.
• Does depreciation reduce property taxes? No, it reduces taxable income for federal tax purposes.
• What happens when I sell the property? Depreciation may be subject to recapture taxes.

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 understand how federal income tax depreciation works. Under IRS rules, residential rental property is typically depreciated over 27.5 years, allowing you to deduct a portion of the building’s value annually to account for wear and tear. This reduces taxable rental income but does not affect your property tax assessment under California law.

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.

Can You Claim a Home Office Deduction for an ADU?

If you use your ADU exclusively and regularly for business purposes, you may qualify for a home office deduction.

The key requirement is that the space must be used solely for business and not for personal use.

What May Be Deductible

• A percentage of utilities
• A percentage of property insurance
• Maintenance costs
• Depreciation (if applicable)

How It’s Calculated

1. Determine the square footage of the ADU used for business.
2. Divide it by total home square footage.
3. Apply that percentage to eligible expenses.

Quick Answers

• Can I use the ADU as both a guest house and office? No. Mixed-use typically disqualifies the deduction.
• Is the simplified home office method allowed? Yes, depending on IRS eligibility rules.
• Do I need to own a business? Yes, the deduction is generally for self-employed individuals.

How to Claim ADU Tax Benefits on Your Return

Claiming ADU-related tax benefits depends on how the unit is used.

General Overview

• Rental income and expenses are reported on Schedule E.
• Home office deductions may be claimed on Schedule C (if self-employed).
• Energy credits are typically claimed using IRS energy credit forms.

Basic Checklist

• Maintain organized expense records.
• Separate personal and rental costs.
• Retain receipts and invoices.
• Confirm eligibility before filing.

Quick Answers

• Do I need professional help? It’s strongly recommended due to complex rules.
• Can I amend a previous return? Possibly, if eligible credits or deductions were missed.
• What documentation should I keep? Receipts, invoices, utility statements, and proof of rental activity.

Are There Any Active ADU Grants in California?

California previously offered ADU grant programs, but many of those programs have expired or exhausted funding.

Local housing authorities occasionally introduce limited-time incentives, but availability changes frequently.

Past Programs

• California ADU Grant Program (up to $40,000) — no longer active
• Local municipal assistance programs — limited and location-specific

Quick Answers

• Will California pay you to build an ADU? There is no active statewide grant program at this time.
• Are city-level incentives available? Some cities may offer fee reductions or pilot programs.
• Should I wait for new grants? Programs are unpredictable and often limited in funding.

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.