What is an 'Accessory Dwelling Unit (ADU)'

An accessory dwelling unit (ADU) is a legal and regulatory term for a secondary house or apartment that shares the building lot of a larger, primary house.

BREAKING DOWN 'Accessory Dwelling Unit (ADU)'

The accessory dwelling unit, or ADU, is also known as an in-law or mother-in-law unit, secondary dwelling unit, granny flat or carriage house. An ADU has its own kitchen, living area and a separate entrance. An ADU may be attached to a house or garage, or it can also be built as a stand-alone unit, but it generally will make use of the water and energy connections of the primary house.

After the housing boom that came after World War II, most U.S. residential areas were zoned to set limits on population density as well as the size and separation of single-family dwellings. More recently, zoning changes in a growing number of areas around the country allow for the addition of accessory dwelling units. These zoning laws generally limit the size and style of any new unit and require that the owner live on the property. 

Pros and Cons of Constructing Accessory Dwelling Units for Rental Income

While many people build accessory dwelling units to house family members, many others do so for rental income. Whether this is a wise investment varies from one landlord to another, depending on a number of factors including local zoning ordinances, upfront costs and ongoing maintenance costs, possible tax consequences and activity in the rental and housing market more generally.

Investors should first investigate whether building an ADU on their property is lawful. If one builds an unlawful ADU, there can be problems if an owner has to refinance the property. Building an unauthorized ADU can also lead to possible code enforcement actions that result in fines. Owners should look to their zoning ordinances and possibly consult with a lawyer specializing in this area.

Then there is the matter of costs. Will the ADU attached to the owner’s home or will it be detached, such as in the case of a carriage house? What renovations will be required, and will the owner need to solicit professional services by construction contractors, engineers or surveyors? The most efficient method of financing an ADU also varies depending on the owner’s individual situation. Options include taking out a renovation loan, refinancing if one has equity in their home or else pulling from available cash on hand.

Constructing an ADU could also mean a hefty tax bill, possibly limiting overall profit. The housing and rental market varies significantly state by state and city by city. Potential landlords should consult real estate agents or do personal research by looking at rental listings and assessing rental rates in their local area. Once they determine the likely overall annual income from their ADU, they can consult with a tax professional to gauge whether their financial situation makes investing in an ADU a beneficial investment.

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