Renting your ADU to family: what a discount does to your taxes

Somewhere between a third and half of the ADU owners I talk to have thought about putting a family member in the unit. Aging parents, a kid who can't afford to leave the Bay Area, a sibling between houses. It's one of the better reasons to build one.

Then they charge $1,800 for a unit worth $3,200, because charging your mother market rent feels absurd, and they carry on deducting the depreciation and the insurance and the new water heater. That last part is where it goes wrong.

I'm not a CPA and this isn't tax advice. But this comes up often enough that you should know the shape of it before you set a number, because the fix is easy in advance and painful in April.

The rule that catches people

Under Section 280A of the tax code, any day you rent a dwelling for less than a fair rental price counts as a day of personal use. Not a rental day. Personal use, as though you'd been living in it yourself.

Rent the ADU to your father all year at a discount and you've got 365 personal use days and zero rental days. The unit isn't a rental property for tax purposes anymore. The income still has to be reported. The deductions largely don't survive: you can't take a loss, and your expenses generally can't exceed what you collected in rent.

So the owner charging $1,800 instead of $3,200 isn't just giving up $16,800 a year in rent. Depending on their situation, they may also be giving up the depreciation deduction that was quietly making the whole thing work on paper.

The exception people don't know about

This gets left out of most warnings about family tenancies, and it's the part that matters.

Renting to a relative is not itself the problem. Per IRS Publication 527, a family member's use doesn't count as personal use if they're using the unit as their main home and paying a fair rental price. Both conditions, together.

So your mother can live in the ADU. She can be your tenant for ten years. If it's her primary residence and she's paying roughly what the unit would fetch on the open market, it's an ordinary rental and you treat it like one. The relationship isn't what triggers 280A. The discount is.

That reframes the decision. It's not "family or deductions." It's "how big a discount, and is it worth what it costs."

What a fair rental price looks like around here

Fair rental price means roughly what a stranger would pay for a comparable unit in your area. Nobody expects a formal appraisal, but you do want to be able to show your work.

Some current numbers to anchor against. As of August 1, RentCafe puts the average rent in the city of Santa Clara at $3,671, up 6.82% from $3,437 a year earlier. By size, that breaks out to about $2,650 for a studio, $3,327 for a one-bedroom, and $4,088 for a two-bedroom. Most Bay Area ADUs are studios and one-bedrooms, so that middle band is usually the relevant one.

Apartment List, measuring differently, has Santa Clara up 8.3% year over year and San Jose up 6.5%. The two don't agree precisely, which is normal and fine. What matters is that both show rents moving up meaningfully, and that a number you set as "market" three years ago probably isn't market now.

That drift is the quiet danger. An arrangement that started at a defensible rent in 2023 can slide into below-market territory without anyone changing anything, purely because the market moved. If you've got a relative in the unit on a rent you haven't looked at since they moved in, look at it.

A reasonable discount for a genuinely lower-maintenance tenant is defensible. There's no bright-line percentage in the statute, which cuts both ways. Small and documented is a much easier conversation than large and improvised, and if you're anywhere near the line, that's a question for your CPA rather than for me or for a blog post.

If you want to give them the break anyway

Plenty of people will read all of the above and still want to charge their kid half. That's a completely legitimate choice, and you should make it with the price tag visible.

Run the arithmetic both ways before you decide. Take the market rent, subtract the discount you want to give, then separately estimate what the lost deductions are worth to you at your marginal rate. For an owner with real depreciation on a recently built ADU, the second number is sometimes larger than the first, which surprises people.

There's also a structural question worth raising with your accountant, which is whether to charge market rent and help the family member separately rather than burying the help in a below-market rent. I'm not going to tell you that works in your situation, because gift rules and your own circumstances drive it and I'm not qualified to run that analysis. I'm telling you it's the question to ask, because most owners never ask it and just quietly set a low number.

What to keep in a folder

Whatever you decide, document it at the time rather than reconstructing it later.

Keep three or four comparable listings from the month you set the rent, screenshots or printouts, showing what similar units were asking. Keep a real written lease, the same one you'd use with a stranger. Run the rent through a bank account rather than taking cash, so there's a record of what was paid and when.

If your relative is on a below-market rent deliberately, write down why and what the market number was. A file that shows you knew the rule and made a considered choice is worth a great deal more than a file that shows nothing.

And revisit the rent annually against comps. That's good practice regardless, but it's what keeps a fair-market arrangement from drifting into a below-market one while you weren't watching. If the rest of your rental picture is in order, the ordinary rules on what your ADU should earn are the right starting point for the comps.

One more thing about timing

Third-quarter estimated taxes are due September 15. If you've been treating a family tenancy as a straightforward rental and it isn't one, that's a number you'd rather correct now than discover next spring. Same if you're mid-year into a new ADU and haven't thought about how the first year of depreciation interacts with any of this.

None of this should talk you out of housing your family in your ADU. It's one of the best uses for the thing. Just set the rent on purpose, write down why, and know which of the two boxes you're choosing to be in. The screening and lease process can be lighter for a relative. The paperwork shouldn't be.

Want to know what your ADU would rent for on the open market, whether or not you plan to charge it? Get a free ADU rental analysis and I'll pull real comps for your unit. Or call me at (408) 813-8001.

Sources

• Publication 527, Residential Rental Property — Internal Revenue Service
• Topic no. 415, Renting residential and vacation property — Internal Revenue Service
• Estimated taxes FAQ and due dates — Internal Revenue Service
• Average Rent in Santa Clara, CA — RentCafe, using Yardi Matrix data
• San Francisco's Rental Market Is Booming Again — Apartment List
• 26 U.S. Code Section 280A — Cornell Legal Information Institute