How does your accessory dwelling unit deliver California tax benefits? We talked with Edward Markaryan, a CPA specializing in tax strategies for real estate investors to find out. We asked all the questions you need answering, and we started with the big one…
How Does an ADU Affect My California Property Taxes?
- An ADU does not trigger a full reassessment of your California property tax
- Your Prop 13 protections remain intact
- You are taxed (typically) 1.2% of the ADU’s assessed market value, this value is added to your current California property tax bill
- The assessed market value is not always equal to the cost to build.
This might be the most popular ADU-related tax question, but there are all sorts of tax-related benefits to adding a Backyard Home.
You can take a listen as I interview Ed on everything from tax matters relating to building costs to tax-saving strategies for investors and homeowners using the ADU to shelter family members. Or, you can skim the blog post below.
Before we get started it is super important to note- we are not giving ANYONE specific tax advice. Use our ideas as jumping-off points to research how these ideas apply to your unique tax situation.
Tax Benefits of ADU Building Costs For Personal Residence
All of the money you use to build your Backyard Home adds to your cost basis. Your cost basis equals your purchase price plus improvements over the years. A higher cost basis translates into less money owed on capital gains taxes when you sell, so this is good!
If your ADU is a rental unit there is an immediate tax benefit called depreciation. The value of the added ADU is divided by a number of years (often 27.5) and each year you can add that slice as an added deduction against your income.
Income Tax Benefits For ADU
Homeowners are limited to $10,000 in total deductions for property taxes and they can only deduct mortgage interest costs on the first $750,000 of their mortgage.
An ADU, used as a rental, can help. The allowable deductions for an ADU rental are separate from the principle residence, but the property tax and, sometimes, mortgage are blended. A talented CPA could document a higher deduction for the homeowner with an income-producing ADU.
House A Relative, Get A Tax Benefit!
Under normal circumstances you do not get any sort of tax benefit for housing a relative.
BUT. Should you charge said relative a normal market rent to live in your ADU you could take the full deductions allowed for income-producing property. The IRS does not care if you happen to “gift” up to $16,000 per year to that same relative. #ifyouknowyouknow #loveyourCPA
The Best Home Office, EVER… With Tax Benefits
Our workspace priorities have changed after COVID and some of us choose to work from home.
An ADU is a brilliant way to separate home life and work life… and it can also deliver a brilliant tax deduction.
Now- there are some pretty strict rules around home office deductions, so check with your own tax professional first, but here is the general advice Ed shared.
Your home office needs to be used exclusively and regularly as a home office. If it is you could take a simple deduction of $5/sf up to $1500. Not bad, but the real play is “actual expenses”. Calculate the percentage of total housing square feet dedicated to your home office. You can take that percentage of all expenses- mortgage interest, property tax, utilities, insurance, etc. as a deduction!
Ed shared some additional strategies that could increase those deductions if you had an S corporation. Check out min 13:15 for those details. I suspect they were brilliant ideas, but a touch over my head.
On Short Term Rentals…
The depreciation on a short-term rental is 39 years instead of 29.5. This means a smaller deduction each year on your income tax form.
The good news is that short-term rentals are assumed as an “active” activity, which has better tax benefits than a “passive” activity.
However, in order to qualify as a short-term rental and get all the tax benefits, you need to rent the unit for more than 14 days out of the year.
Keep The Documents To Get The Tax Benefits
In order to get the maximum tax benefits from increasing your cost basis and depreciation, it is important to keep any documentation on your build costs in a safe place. It could be years or even decades before you will need to document the cost of building your ADU.
If you are renting your ADU, long term or short term, get a Quickbooks type system or hire a book keeper to track your profit, losses and expenses for your tax return.
Work With ADU DIGGS
We make architectural ADUs easy and accessible. Our White-Glove all-in service means all you need to do it pick a model and finishes. We take care of everything else.
Select your favorite model and floor plan, HERE. WE are adding new options soon!
How To Reach Ed
Edward Markaryan, CPA, MST
Armanino LLP
213-334-7263 / edward.markaryan@armaninollp.com