In this article we aim to provide a general explanation of how building an ADU affects your property taxes. Keep in mind though that specific rules and exemptions vary by location and jurisdiction.

Does adding an ADU increase Property Taxes?

Building an ADU will raise your property taxes due to the increased value of your property, but not as much as you may imagine. The good news is that in California adding an ADU does not trigger a property tax reassessment of the existing main home. Only the ADU itself will be assessed, much like doing a home addition. The property tax of the ADU will be determined by the market value of the ADU and the property tax rate (typically 1-1.25%) of your local jurisdiction. This tax will be added to your current tax bill, making it a blended rate of your current property tax rate and the new one. Over time, your tax rate can increase but it is capped at 2% per year thanks to Proposition 13.

How is property tax calculated for an ADU in California?

The calculation for property tax for an ADU is as follows:

Property tax = Assessed value of ADU* x Property tax rate

For example, if an ADU has an assessed value of $100,000 and the property tax rate in your area is 1%, the homeowner would be taxed $1,000 annually for the ADU.

Note that in California, property taxes are determined based on the assessed value of your home rather than its current market value. A tax assessor will typically determine the assessment value by taking the market value of your ADU and multiplying it by an assessment rate that’s specific to your local area.

The market value of your ADU may be based on:

1. Performing a sales comparison evaluation of similar homes in your area with ADUs
2. Determining cost to build or replace the ADU
3. Evaluating the ADU’s income potential

At HOMEPLEX, we generate sales comparables to determine the added value an ADU would add to your property.

Does adding an ADU increase my property value?

The increased value of your property will depend on various factors, including the ADU’s size, the quality of materials used, its conformity with the main home and/or neighborhood, and local housing market conditions. While the actual construction and startup costs can vary significantly, it is generally believed that the value added to the property outweighs the initial expenses. Research indicates that properties with ADUs typically command higher selling prices compared to those without, reflecting the demand for additional living spaces and potential rental income. It’s crucial to consider the costs of adding an ADU, including construction expenses and associated soft costs, in relation to the anticipated increase in property value.

How does an ADU help with taxes in California?

One way you can decrease the taxes associated with having an ADU is by factoring in depreciation. Depreciation is a tax deduction that allows you to deduct a portion of the cost of your ADU over a period of several years. This can significantly reduce your tax liability and help you save money in the long run. You may even accelerate this process through cost segregation strategies.

If you plan to rent out your ADU, you may be eligible for additional tax deductions. Expenses related to renting out your ADU, such as insurance, taxes, utilities, repairs, and maintenance, may also be deducted from your taxes. Rental income from your ADU can be offset by the costs of building and maintaining the ADU unit, reducing your overall tax liability.

Talk to a tax professional to learn more about how depreciation, cost segregation, and rental deductions work and how they can benefit you when building an ADU. Besides taxes, financing an ADU can be a challenging part for homeowners. If you’d like an overview of your options, check out this guide on getting started with financing an ADU.

ADU Tax Credit and Tax Deductions in California

In California, ADUs can provide certain tax benefits and incentives for homeowners. The state has implemented policies to encourage the construction of ADUs to address the housing shortage and increase affordable housing options. Below are a couple of examples of tax credits and incentives:

• Solar Tax Credit: Allows homeowners to subtract 30% of the cost of installing solar heating, electricity generation, and other solar home products from their federal taxes. This credit applies to solar systems that are purchased, not leased or a member of a power-purchasing cooperative.

• CalHFA’s ADU Grant Program: A state program offering $40,000 towards pre-development and non-reoccurring closing costs associated with the construction of the ADU to encourage housing development in California.

In addition, certain districts may provide tax incentives like waivers and caps on increases. Homeowners should research their local city or county’s tax incentives to understand what other tax deductions they can take advantage of.

As income property specialists, we can help you take advantage of tax incentives you may not have ben familiar with.

How ADUs Affect Your Taxes

The impact of Accessory Dwelling Units (ADUs) on your taxes can vary depending on several factors. Firstly, adding an ADU to your property will likely increase its assessed value, leading to marginally higher property taxes. However, you may also be eligible for certain deductions or credits related to the expenses incurred in constructing and maintaining the ADU. For example, the solar tax credit and tax incentives and exemptions from your local jurisdiction can help mitigate the tax burden.

Additionally, if you rent out the ADU, the rental income must be reported and may be subject to income taxes. However, you can deduct costs related to renting out your ADU as business expenses.

It’s important to consult with a qualified tax professional to understand the specific implications of ADUs in your local area, including property taxes, rental income taxes, and any potential tax benefits that may be available to you. By considering all these factors, you can make informed decisions regarding ADUs and effectively manage their impact on your taxes.

Our Final Thoughts

There is no denying that Accessory Dwelling Units (ADUs) have gained popularity as a housing solution in recent years, offering homeowners the opportunity to create additional living spaces on their properties. As the demand for affordable housing options and multi-generational living arrangements grows, ADUs, also known as granny flats, in-law suites, or secondary dwellings, have emerged as a viable solution in many communities.

Property taxes play a significant role in the overall cost of homeownership, and it is important to understand how much the addition of an ADU will lead to an increase in property tax assessments. By examining the potential impact of ADUs on property tax assessments, homeowners, prospective ADU builders, and policymakers can gain insights into the financial implications of ADU construction and know when it makes financial sense to build.