An Accessory Dwelling Unit (ADU) is more than just an added structure on your property. It represents potential rental income, increased property value, and versatile living or working space. Read more about the benefits of ADUs including their role in supporting multigenerational living.
But with this significant investment comes important questions about taxation, insurance, and financial implications in California. Before diving deep into ADU tax-related intricacies, it’s crucial to understand how ADUs affect your property taxes and what tax deductions you might be eligible for. Here’s a comprehensive guide on ADU property tax adjustments, tax deductions, and credits relevant to ADUs in California.
Does Adding an ADU Increase Property Taxes in California?
Does adding an ADU increase property taxes in California? Yes, but only for the new structure, not your entire property. Adding an ADU does not trigger a reassessment of the primary residence. In California, only the ADU is reassessed, and its value is added to your existing property assessment. This is known as a blended assessment. Keep reading to learn how this impacts your tax obligations.
How ADU Value is Calculated for Property Taxes in California
When adding an ADU, your property is not reassessed as a whole. Instead, only the ADU is subject to a new property assessment, leaving your primary residence’s value untouched. California uses the market value of the new ADU or construction costs as a basis for determining the additional property taxes.
How Much Does an ADU Increase Property Taxes in San Diego?
Generally, property tax rates on ADUs are in the range of 1-1.5% on the build cost. So, for example, if the construction cost of your additional unit is $300K, you might expect to pay around $3,000 in additional taxes per year. Be sure to consult with a tax professional to confirm the impact in your specific scenario with a San Diego ADU property tax adjustment.
Throughout California, newly constructed ADUs are assessed at market value as of the date of completion. Typically in the San Diego area, assessors will use the cost of construction to value the new guest house. Often assessments value the improvements at “wholesale” costs, e.g. considerably lower than it actually cost to build the guest house.
How San Diego County Reassesses Property Taxes for ADUs
The San Diego County Assessor’s Office receives copies of all building permits issued by the cities as well as the County. The Permits are then divided into two categories: (1) permits for repair, replacement and maintenance, and (2) permits for actual new construction. In addition to obtaining the building permit information, the Assessor’s Office mails out a questionnaire to the property owner seeking information on the specific cost of construction and the actual size of the addition.
For new construction, there is typically a reassessment for the new square footage added. In appraising new construction, the market value of the addition is determined by the Assessor’s Office and added to the value of the existing property. The value of the existing property does not change. For example, a homeowner currently has a 2,000 sqft home and builds a new 500 sqft ADU. Under Proposition 13, the County can only reassess the new ADU, and not the existing home.
When Will the ADU’s Property Tax Increase Take Effect?
All municipalities must notify the County Assessor’s Office whenever building permits are issued. After the reassessment for new construction has been completed by the assessor’s office, the property owner is notified in writing of the new assessment. Since changes are reflected on the next regular property tax bill, it can take up to a year to run through the process before the new tax assessment becomes active.
California state law also requires the assessor’s office to appraise all new construction on January 1st to determine the value for property tax purposes. This taxable value is then reflected on the next regular property tax bill. As with a change-in-ownership, the owner is notified of the new assessment and can appeal the value.
ADU Tax Deductions in California
While an ADU increases your property taxes, it can also open up opportunities for tax deductions. Whether your ADU is used as a rental unit or for a home office, you may qualify for ADU tax deductions in California.
Can I Deduct ADU Construction Costs on My Taxes?
Yes, in certain situations, ADU construction costs can be deducted. For example, if you rent out your ADU, the construction costs may be tax-deductible over time through depreciation. Additionally, costs associated with utilities, maintenance, and upgrades may also be deductible if the ADU is rented out or used for business purposes.
Is Building an ADU Tax Deductible?
Building an ADU can be tax-deductible if it is used for rental purposes or business activities. You may be able to deduct a portion of the construction costs, as well as ongoing expenses such as maintenance, utilities, and repairs. Consult a tax professional to explore the best deductions for your ADU.
What About Capital Gains Taxes?
When you ultimately sell your property, you would be subject to capital gains taxes, as you are with any home. But keep in mind that if the property is considered your primary residence, you may exclude up to $250,000 (or $500,000 for married couples filing jointly) of your capital gains from taxes. So unlike a separate investment property that does not count as a primary residence, you would enjoy a tax shelter when it comes time to sell a property with an ADU. This is one of the many reasons an ADU can be a great investment.
Your gain will be calculated as: Home’s selling price – Selling Costs – Tax Basis. And what is the tax basis? That would be your original purchase price for the home, plus expenses related to the purchase, plus the cost of capital improvements (like adding an ADU!), minus depreciation and insurance payments.
For example, let’s say you and your spouse bought a house for $1,000,000, with purchase expenses of $20,000. You add a large ADU at a cost of $380,000. You later sell the property for $2,000,000 with selling costs of $100,000. This would mean you would owe zero capital gains tax. ($2M sell price – $100K selling costs – $380K improvements – $1M purchase price – $20K purchase expense = $500K – $500K deduction = 0).
ADU Tax Credit California: Are You Eligible?
While there isn’t a specific ADU tax credit in California, using an ADU for eco-friendly purposes may make you eligible for certain energy-efficient tax credits. Additionally, you may qualify for state or local incentives if your ADU includes solar panels or other energy-efficient upgrades. These tax benefits can reduce the overall cost of maintaining your ADU.
How to Use Your ADU for Additional Tax Benefits
The way you use your ADU – whether for rental income or as a home office – can impact your eligibility for tax deductions and other tax benefits.
Using an ADU as a Rental
If you rent out your ADU, the rental income is taxable. However, you may be able to deduct related expenses such as property management fees, repairs, and utilities. You can also depreciate the ADU over time, reducing your tax liability each year.
Down the line when you decide to sell your property, you will be able to write off your guest house construction costs at that time, given the change in value and the cost of the improvements you made as described above.
Using an ADU as a Home Office
If you use your ADU as a home office, certain expenses, such as maintenance, insurance, and utilities, may be tax-deductible. Additionally, part of the construction cost may be deductible if the space is exclusively used for business purposes.
If you choose to run your small business out of your newly built accessory dwelling unit, you may be able to depreciate part of the construction of your ADU, as well as any work you put into the space (so long as it is related to your business).
Again, it is always best to consult a tax professional before taking any action regarding your property and its value.
What is the county assessor’s form as it relates to ADU taxes?
Once the county is aware of the ADU completion via the building permit, they will mail a form titled “Property Owners Declaration of New Construction.” State law requires property owners to provide construction costs to the assessor’s office for tax assessment purposes.
You will be asked to fill in the following information in the form: construction costs, total bedrooms and bathrooms after adding the ADU, the the type of new construction.
- Describe Type of New Construction: example: “Construction of new detached, one bedroom, one bathroom, 491 square foot accessory dwelling unit.”
- Total Bedrooms and Bathroom: Add the ADU bedrooms and baths to the primary dwelling unit count for the revised number.
- Construction Costs: Use $130.58 x ADU Square Feet
Although you may have specific costs for your ADU construction, we are noting that jurisdictions in Greater San Diego typically use a standardized value per square foot for valuations. The often-used rate is $130.58/SF. However, in February 2023, the International Code Council updated the rate to $149.80/SF (February 2023 Building Valuation Data, ICC). Still, several cities continue to use the $130.58/SF rate in their valuations (February 2021 Building Valuation Data, ICC).
Depending on when the unit is completed, the form may arrive quickly or may take some time. Regardless, the County Assessor monitors all building permits and will mail you a form.
Reach out to experts for your unique situation
The insights shared in this technical blog are derived from our extensive expertise in the field, encompassing hands-on experience in design, development, and implementation. We are committed to delivering accurate and current information; however, it’s important to acknowledge the dynamic nature of the ADU space, which may lead to changes affecting the details discussed in this blog.
SnapADU is dedicated to empowering our readers with valuable insights and practical knowledge, enabling them to navigate the constantly evolving accessory dwelling unit landscape. We invite you to connect with our experts to receive personalized guidance and to remain informed about the latest advancements within the field.
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