State regulations have indefinitely removed owner occupancy requirements for accessory dwelling units (ADUs). However, junior ADUs (JADUs) still present ambiguity around ownership structures. For example, can investors build both an ADU and a JADU? Below is our take on these questions, but consult legal sources for confirmation.
Current Owner Occupancy Requirements ADUs
As of September 2023, California no longer requires owner occupancy for ADUs. You can build an ADU on rental property and rent out all units. You must comply with local rental regulations, which may require a minimum rental period of 30 days.
Section 65852.2 of the Government Code states: This subdivision establishes the maximum standards that local agencies shall use to evaluate a proposed accessory dwelling unit on a lot that includes a proposed or existing single-family dwelling. No additional standards, other than those provided in this subdivision, shall be used or imposed, including an owner-occupant requirement, except that a local agency may require that the property be used for rentals of terms 30 days or longer.
In the past, owner occupancy was eliminated for ADUs permitted between January 1, 2020, and January 1, 2025. Local agencies could not retroactively impose occupancy rules on those ADUs.
In San Diego, owner occupancy requirements have been entirely removed, as stated in the ADU Information Bulletin 400 from December 2020. Per this text, the property owner is not required to live on-site.
If a property contains both an ADU and a JADU, the owner must live in either the JADU or the main house. If you move, renting out the JADU is no longer allowed unless the primary residence remains owner-occupied.
Can LLCs or S-Corps Own Properties with JADUs?
Complex questions arise when determining if legal entities, like LLCs or S-Corps, can meet ADU owner occupancy requirements. California law doesn’t clearly define “owner-occupied,” a term often used for tax purposes. In legal terms, an LLC or S-Corp is a non-living entity and doesn’t meet owner-occupancy criteria.
Some cities, like Carlsbad, mention “owner-occupied” only when converting a primary dwelling to a rental, without defining the term. Encinitas is more specific, requiring the owner to live in either the primary dwelling or the JADU. In San Diego, “owner” is defined as someone who owns and lives on the property, which excludes LLCs and S-Corps.
Definitions for LLCs and S-Corps in Relation to Owner Occupancy
To meet owner occupancy requirements, a living person must live in the home for most of the year. A legal entity cannot occupy property, making it unlikely that LLCs or S-Corps will qualify as “owner-occupants” for JADUs.
Nevertheless, the LLC or S-Corp can buy and hold real estate (learn more about how to set up an LLC for investments). And as far as the IRS is concerned, the single member LLC/S-Corp will be treated the same as a single person living in their home. So, a single person LLC/S-Corp wouldn’t receive the benefit of renting to themselves.
Does Owner Occupancy Require a Real Person for a JADU?
Yes, ADU owner occupancy requirements generally require a living person to reside in the home. An LLC or S-Corp does not qualify as a “person” under this definition. However, since municipal codes lack clarity, it may be worth exploring whether single-member LLCs or S-Corps can qualify when the sole member lives on-site.
Can Investors Structure Ownership for Tenants to Meet Occupancy Rules?
Investors could consider drafting a lease where tenants receive an ownership stake in the LLC or S-Corp that owns the property. This exchange would involve granting a leasehold interest in return for shares or interest in the legal entity (LLCs have ‘interests’ and S-Corps have ‘shares,’ otherwise they are similar). There’s no legal barrier to this kind of contract, but it may raise valuation and tax questions.
Would It Require Amending Corporate Documents to Make the Tenant a Member?
To add a shareholder, an existing shareholder must transfer shares, or the corporation must issue new shares.
If the corporation issues shares, two options exist:
- Issue Stock Certificate: If the corporation holds treasury stock, it can issue those shares to the new shareholder. No need to amend the articles of incorporation, charter, or bylaws. The corporation would issue a new stock certificate and record it in the stock ledger.
- Amend Corporate Charter: The S-Corp must review its articles of incorporation to check the number of authorized shares. If authorized shares are available, the corporation issues a stock certificate. If not, it must amend the articles of incorporation to increase the number of shares, subject to Board approval.
What are the financial implications of issuing shares/interest?
Issuing shares without a cash or property investment creates tax implications. The fair market value (FMV) of the shares must be included as taxable compensation on the recipient’s tax return. A leasehold may not be a sufficient property interest to offset this value.
The corporation would issue a W-2 to the recipient, treating the FMV as salary, which the corporation can deduct. Since FMV valuation could raise audit concerns, consult a tax advisor before proceeding.
In conclusion, we really know our stuff when it comes to ADUs, as we have extensive experience in design, development, and implementation. While we put a lot of effort into providing accurate and up-to-date information, it’s important to keep in mind that the ADU space is always evolving due to regulation changes and differences in local interpretation. That means that the details discussed in the blog might be subject to change.
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