This page contains general information only and is not tax advice. Consult a licensed CPA or tax attorney for advice specific to your situation. Outcomes depend on facts ADUscale does not know: filing status, other income, prior depreciation, the use pattern of the ADU, county assessor practice, and law changes since publication. Treat what follows as a map. Your CPA draws the route.
California Property Tax — Prop 13 and the ADU
Proposition 13 caps annual property-tax increases at 2% of base-year value and resets only on a change in ownership or qualifying new construction. Under Cal Rev & Tax Code §68 and the BOE assessor handbook, adding an ADU triggers an assessment only on the new structure. The existing home keeps its base-year value under Cal Rev & Tax Code §51.
- Home assessed at $350,000 (1998 purchase) — base-year value stays protected under Prop 13
- You build a $280,000 detached ADU in 2026
- Assessor keeps primary home at $350,000 plus the 2% annual factor
- ADU is assessed at current market value (~$280,000)
- At ~1.15% effective rate (CA county average): ADU adds roughly $3,200/year
Federal Income Tax — Rental Income
ADU rent is ordinary rental income, reported on Schedule E (Form 1040) per IRS Publication 527. Allowed deductions, allocated to the ADU portion: mortgage interest, property tax on the ADU portion, insurance, repairs, maintenance, utilities you pay, depreciation, property management fees, advertising, and screening costs.
The mixed-use point homeowners get wrong. If you live on the property and rent only the ADU, the ADU is a separate dwelling unit for tax purposes. The personal-use limits under IRC §280A (the vacation-home rules that cap deductions when you personally use the unit) do not apply to a separately occupied ADU you do not personally use, provided you rent at fair market rent.
Passive activity. Rental income is generally passive under IRC §469. Homeowners with active participation may deduct up to $25,000 against ordinary income, phasing out between $100K and $150K MAGI. California conforms; passive-loss limits go on FTB Form 3801.
Depreciation
The ADU structure is residential rental property under IRS Publication 946, depreciated 27.5 years straight-line under the General Depreciation System, as classified in IRS Rev. Proc. 87-56. Land is not depreciable; you allocate basis between land and structure.
- Total cost basis: $280,000
- Land allocation 20%: $56,000 (not depreciable)
- Depreciable structure basis: $224,000
- Annual straight-line: $224,000 ÷ 27.5 years
Cost segregation reclassifies portions of the structure into 5-year (appliances, carpet) and 15-year (site work) classes under Rev. Proc. 87-56, accelerating early-year depreciation. Studies typically pencil only above $300,000 of total project cost. Talk to your CPA before commissioning one.
Does the project pencil after tax?
The $199 Feasibility & Risk Assessment pressure-tests the financing path and rental thesis against your equity position and county assessor practice. Credits in full against any Owner's Rep engagement.
Capital Gains on Sale
Two federal rules collide when you sell.
Depreciation recapture under IRC §1250. All depreciation you took (or were allowed to take) on the ADU is recaptured at a maximum federal rate of 25% on sale, whether or not the rest of the gain qualifies for the §121 exclusion. The 25% on the depreciated portion is unavoidable.
Primary-residence exclusion under IRC §121. A single filer can exclude up to $250,000 of gain; married filing jointly, up to $500,000. Qualifying requires ownership and use as a primary residence for at least 2 of the last 5 years. The exclusion applies to the whole property, ADU included, when the tests are met.
Non-qualified use carve-out under IRC §121(b)(5). Gain attributable to periods of non-qualified use after January 1, 2009 (typically when the ADU was rented rather than used as your residence) is not excludable. The non-excludable fraction is total non-qualified-use period ÷ total ownership period. Your CPA does this calculation. California conforms to §121.
Citable Facts
FAQ
Read again before you act. This page contains general information only and is not tax advice. Consult a licensed CPA or tax attorney for advice specific to your situation. Federal and California tax law changes. IRS publications update annually. Assessor practice varies by county. Your filing status, other rental activity, AGI, and ADU use pattern change the math. Anchor decisions on a written analysis from a licensed professional.
Yaro Korets — Founder, ADUscale
Yaro Korets, Founder of ADUscale. ADUscale is a California build-side ADU partner: we help homeowners secure one of the state's top contractors, expand that contractor's capacity to take the project, and protect the budget with inspection-gated milestone payments — at the same price as going direct. Not a lender or financial advisor — we help you find the right financing and connect you with a lender. Tax content anchored to IRS Publication 527, Publication 946, Rev. Proc. 87-56, IRC §121, IRC §1250, Cal Rev & Tax Code §68, and the California BOE framework. ADUscale is not a CPA, tax attorney, or financial advisor. Consult a licensed professional before making tax decisions.
Last updated: June 2026.