Renting out an ADU or in-law unit: a playbook for the landlord next door

An ADU, a basement apartment, or an in-law suite is the easiest rental to start and one of the hardest to run well, because your tenant lives a few steps from your kitchen. You share a lot, maybe a driveway, maybe a water heater, and you see each other most days. Here is a playbook for renting one out: the local rules, the price, the lease, the utilities, the money, and the taxes.

You are not the only one doing this

Backyard and basement units have gone from a curiosity to a real share of new housing in some states. According to the California Department of Housing and Community Development, California permitted 30,354 ADUs in 2024, which was 26.6% of all homes permitted in the state that year. A 2021 survey of California ADU owners by UC Berkeley's Terner Center found that 51% of new ADUs were income-generating rentals, while 16% housed a relative or friend for free.

So if you are building one, or converting a basement you already have, renting it out is a normal path. The difference from a regular rental is that you are also the neighbor.

Check the local rules before you list

ADU and basement apartment rules are set city by city and county by county, and they change often. Before you take a deposit, find out:

• Whether the unit is legally permitted as a dwelling. A finished basement is not automatically a legal apartment. Many places require a permit, an inspection, or a certificate of occupancy before anyone can live there.
• Whether an owner-occupancy rule applies. Some places require the owner to live in either the main house or the ADU. Others have dropped that requirement. Check what applies to your address.
• Whether short stays are allowed. Some cities let ADUs be rented only on longer leases, not as short-term rentals.
• Whether you need a rental license or registration. Some cities require one for any rental, including a single unit on an owner's lot.
• What safety requirements apply. Basement units in particular can have specific requirements around exits, windows, and smoke and carbon monoxide alarms.

Your city or county planning and building department is the place to ask. This is general information, not legal advice.

Price it like a rental, not a favor

The easiest mistake with an ADU is to price it low because it feels small or because you want a nice tenant. Look at what similar units nearby actually rent for, then adjust for what yours includes:

• A separate entrance and real privacy from the main house.
• Utilities, if you include them.
• Parking, laundry access, storage, and use of the yard.
• Furnishings, if any.

A fair market rent matters for taxes too. If you rent to a relative, IRS guidance in Publication 527 says that when a relative rents your property for less than a fair rental price, those days count as personal use, which limits what you can deduct. If family is moving in, talk to a tax professional before you settle on a number.

Write a lease, even for one tenant

When the tenant is a friend of a friend and the unit is in your own backyard, a handshake feels natural. It is also what turns a small disagreement into a big one, because nobody can point to what was agreed. A written lease protects the relationship as much as it protects you. Beyond the usual rent, due date, deposit, and term, an ADU lease should cover the things that are shared:

• Utilities: what is included, what is billed, and how.
• Parking: which spot, and whether guests can use the driveway.
• Yard, patio, and laundry: what the tenant can use, and when.
• Quiet hours, guests, pets, smoking, and grills.
• How much notice you give before entering the unit, following your state's rules.
• Late fees, if you charge them, within what your state allows.
• Trash and recycling, snow, and lawn care: who does what.

Send the lease for e-signature and keep the signed copy where both of you can find it later.

Shared utilities: pick a simple, honest setup

Many ADUs and basement units share electric, gas, or water meters with the main house. You have three practical options:

To be clear about the software side: RentMerchant does not read meters or split utility bills. If you use a flat charge, the honest approach is to set the monthly invoice to rent plus that flat amount and spell it out in the description, for example "Rent $1,400 + utilities (flat) $100". The tenant sees exactly what they are paying for, and the lease backs it up.

Collect rent without the face-to-face ask

The hardest part of renting a unit next to your own home is asking for money from someone you just waved to. The fix is to take yourself out of the asking.

• A recurring monthly invoice that goes out on its own, on the day you choose.
• Automatic email reminders before the due date and after it passes, so the reminder comes from the system, not from you at the fence.
• Online payment by bank transfer or card, with autopay available on card.
• An automatic late fee, if your lease has one, applied the same way every time.
• A receipt for every payment, and a record of cash or checks when the tenant pays the old way.

If rent is late, the conversation is about the invoice, not about you. Our guide to handling late rent covers the rest.

Privacy and boundaries when the tenant is in your backyard

Good ADU landlords protect their tenant's privacy as carefully as their own. A few habits help:

• Use the door, not the window. Give proper notice before entering, even to change a filter, unless it is an emergency.
• Put requests in writing. Ask the tenant to send maintenance requests through the portal and use messaging for anything else. You both get a record, and nobody has to knock on a door at dinner time.
• Keep the shared spaces defined. If the lease says the patio is the tenant's after 6 pm, honor it.
• Separate the friendly from the business. Chatting in the yard is fine. Rent, repairs, and rules belong in writing.

Taxes: the unit is a rental, your house is not

Rental income from an ADU or basement apartment is generally reported on Schedule E. The tricky part is that the unit sits on the same lot as your home, so some expenses belong to the rental and some do not.

• Expenses only for the unit, like a new appliance in the ADU or a repair inside the basement apartment, generally go to the rental.
• Shared expenses, like property tax, insurance, or a roof over both spaces, are usually divided between your home and the rental using a reasonable method, such as square footage.
• Depreciation generally applies to the rental portion only.
• Selling later can be affected. Renting out part of your home can change how a later sale is taxed, including the home sale exclusion.

Every one of these depends on your situation, so talk to a tax professional. What you can do now is keep clean records: log expenses as they happen, note which are shared, and keep rent records in one place. Our Schedule E guide walks through the categories.

How RentMerchant fits

An ADU is one property, and RentMerchant's Free plan covers up to three properties with the full toolkit, so a single backyard unit costs nothing beyond the per-payment fees. By default the tenant pays those fees and you receive the full rent, and the amounts are listed on the fees page. As an example, a bank transfer on $1,500 of rent costs the tenant $7.00 ($5.00 capped processing plus the $2.00 platform fee). You get the online lease, recurring invoices, reminders, late fees, receipts, maintenance requests, messaging, and an expense tracker with a Schedule E export. Our ADU and in-law unit page shows how it fits together, and you can create a free landlord account before your tenant moves in.