Renting Out an ADU or In-Law Suite: A Tax Guide for Beginners

TL;DR: Once you rent an ADU or in-law suite for money, the IRS treats that portion of your home as a separate rental unit — you allocate shared expenses (utilities, insurance, mortgage interest) by square footage or usage, and you report the rent on Schedule E. Bonus depreciation on qualifying improvements is now 100% and permanent for property acquired after Jan. 19, 2025, and payments to contractors don't require a 1099-NEC until they cross $2,000 per year for work done on or after Jan. 1, 2026. Check local zoning and your mortgage terms before you list the unit — the tax rules only matter once the arrangement is legal.

_Last reviewed: August 2026 · 8 min read_

Turning a spare basement, garage conversion, or backyard cottage into a rental sounds simple until the first tax season arrives and you're not sure which expenses belong to "the house" and which belong to "the rental." The good news: the IRS has a fairly clear framework for splitting a mixed-use property, and most first-timers overpay or underclaim simply because they never set up the allocation correctly.

Okoniq Property Hub logs ADU rent payments, utility splits, and repair receipts in one place, so the numbers you hand your CPA at tax time already match what actually happened.

Is renting out an ADU or in-law suite legal where you live?

Check your local zoning code and your mortgage terms before you sign a lease, because the tax questions only apply once the rental is actually permitted. Many cities restrict accessory dwelling units to family members, cap the number of unrelated occupants, or require a separate rental permit and inspection. Some mortgage agreements and homeowners insurance policies also have language about non-owner-occupied portions of a property, and renting without disclosing it can affect your coverage if something goes wrong.

If the unit was built or converted without permits, get it inspected and permitted before advertising it. A permit issue that surfaces during an eviction dispute or an insurance claim is a far bigger headache than the cost of doing it right upfront. Once the legal side is settled, the tax side follows a fairly standard pattern that mirrors what other first-time landlords run into in year one.

How do you split expenses between the ADU and the rest of the house?

You allocate shared costs by square footage or another reasonable method, and only the rental-attributable share is deductible against rental income. If your ADU is 400 square feet in a 2,000-square-foot home, that's 20% of the property. Apply that same 20% to mortgage interest, property tax, homeowners insurance, and utilities you pay on the whole house, and deduct that portion on Schedule E against the rent you collect.

Expenses that belong entirely to the ADU — a new mini-split system installed only in that unit, paint and flooring for that space, a lock change — are 100% deductible or depreciable against the rental, with no allocation needed. Keeping these two expense buckets separate from day one saves a lot of reconstruction work later. A simple chart of accounts with a category for "ADU-only" and another for "shared, allocated" keeps this from turning into guesswork at filing time.

What can you depreciate and deduct on a rented ADU?

You depreciate the rental-use portion of the structure and can immediately deduct qualifying improvements under bonus depreciation or the de minimis safe harbor. The recovery period for residential rental property is set by statute — confirm the current figure on IRS.gov or with your CPA before running the calculation, since it applies specifically to the depreciable basis of the rental-use square footage, not the whole house.

For separate items you buy for the unit — a refrigerator, a water heater, new carpet — bonus depreciation is now 100% and permanent for qualifying property acquired after January 19, 2025, so many of these can be expensed in the year you place them in service rather than depreciated over several years. Alternatively, the de minimis safe harbor lets you deduct any item costing $2,500 or less per invoice or item outright, without tracking depreciation schedules at all — useful for the smaller purchases that come with furnishing an in-law suite. Repairs versus capital improvements is a common sticking point here; running new purchases through a capitalize-vs-expense decision tree before filing avoids a lot of amended-return headaches down the line.

| | Rental-Only Expense | Shared/Allocated Expense | |---|---|---| | Example | New mini-split in the ADU | Mortgage interest, property tax | | Deduction | 100% against rental income | Allocated share only (e.g., 20%) | | Depreciation | Full basis depreciated or expensed | Only the allocated basis depreciated | | Documentation needed | Receipt tied to the unit | Square footage calculation + whole-house bill |

Does renting an ADU trigger 1099 reporting or affect the QBI deduction?

Renting an ADU makes you subject to the same information-reporting and deduction rules as any other landlord, just scaled to the size of the unit. If you pay a contractor to renovate or repair the ADU, you don't need to issue a 1099-NEC until payments to that contractor exceed $2,000 in a calendar year for work done on or after January 1, 2026 — payments made before that date still fall under the older $600 threshold. Either way, the contractor's income is reportable on their end whether or not you send a form.

If your rental activity rises to the level of a trade or business, you may be eligible for the Qualified Business Income deduction, which is 20% of qualified business income under §199A — now made permanent. Whether an in-law suite rental clears that bar depends on how involved you are and how many hours you put in; a landlord renting one small unit part-time often falls short of the safe harbor tests that make this easier to claim, so this is worth reviewing directly with a CPA rather than assuming either way.

What about selling the house later — does the ADU rental complicate things?

Yes, renting part of your home for money can affect how the sale is taxed down the road, because the rental-use portion of the property doesn't automatically qualify for the same home-sale treatment as the part you lived in. The exact exclusion amounts and depreciation-recapture mechanics are statutory figures you should confirm with a CPA before you list the house, since selling with a documented rental history is a different calculation than selling a home you never rented out. If you're weighing whether to convert the unit back to personal use before selling, the general mechanics of that shift are covered in converting a rental back to a primary residence.

FAQ

Do I have to report ADU rent if I only rent to a family member?

Yes, rent is taxable income regardless of who pays it, though if you charge below fair market value to a relative, different rules may limit which expenses you can deduct against that income. Get specific guidance from a CPA if the arrangement involves family.

Can I use the Augusta Rule for an in-law suite instead of a long-term lease?

The Augusta Rule allows homeowners to rent their home tax-free for up to 14 days a year, but it's designed for short, occasional rentals of your personal residence, not an ongoing ADU tenancy. Read the 14-day rule details before assuming it applies to a unit you plan to rent continuously.

Does converting a garage into a rental ADU count as "converting to a rental" for tax purposes?

Partially — you're converting a portion of your primary residence to rental use, which triggers basis and expense-allocation rules similar to a full conversion, just scaled to the square footage involved. The mechanics are outlined in converting a primary home to a rental.

What records should I keep for an ADU rental?

Keep the lease, square footage calculation, all repair and improvement receipts split by unit, utility bills, and bank records showing rent received. This documentation is exactly what shows up when auditors ask for support on a mixed-use property.

Are everyday supplies for the ADU deductible?

Yes, cleaning supplies, light bulbs, and small maintenance items used specifically for the rental unit are deductible against that rental's income, similar to everyday deductions tracked for any other rental.

This is educational information, not tax advice. Talk to a licensed CPA before acting on anything here, and confirm current figures on IRS.gov.

<div class="glass rounded-2xl p-5 mt-7 max-w-4xl border border-red-400/30 bg-red-500/5"> <div class="flex items-start gap-3"> <span class="text-2xl flex-shrink-0">⚠️</span> <div class="flex-1 min-w-0"> <p class="text-red-200 text-sm font-bold">Not tax advice</p> <p class="text-slate-300 text-xs mt-1 leading-relaxed"> This post assumes a typical owner-occupied home with a rented ADU or in-law suite and uses only figures verified against IRS.gov as of July 2026. It does not account for your tax bracket, state and local rules, entity structure, mortgage or insurance restrictions, or legislation passed after July 2026. Tax rules change and depend on your specific situation. Talk to a licensed CPA before acting on anything here, and confirm current figures on IRS.gov. </p> </div> </div> </div>