While there's two ways to treat this, here's how I would do it. Regardless of the method you chose, there's pros and cons to both.
I'd just add the ADU as an additional asset to the existing rental, classified as residential rental real estate depreciated over 27.5 years. For that asset in the COST box I'd enter the amount I actually paid for that structure. Then in the COST OF LAND box enter zero, because I did not pay anything for the land I already own and built it on.
Pros :
- You just enter one figure for the total rent received from both structures. If you have one structure vacant for a period of time between renters, no big deal. You really don't have any vacant period so long as at least one of the rentals is occupied by a paying renter for the entire tax year. The only way you'd have a vacant period, would be if both rentals were vacant at the same time.
- I don't have to pro-rate and allocate land values between the two rentals, which can make for a "tenie-tiny" hassle adjusting the land value on the existing rental without messing up the existing structure value - which could completely screw up the depreciation history if not done right.
- I don't have to bother with allocating insurance and property tax deductions between two separate rentals. (Assuming you have one policy for the entire property, and did not take out a separate policy for the ADU)
- If I for any reason, convert either one of the units to personal use, it's just a simple matter of converting that one asset to personal use to stop depreciation on that one asset. (converting back to a rental will require manual math and a bit of work on your part, no matter what you do. It's just unavoidable.)
- If you sell the entire property in the future, you only have to report a single transaction, and don't need to bother with splitting it between two separate properties.
- Cons:
- If you sell only one of the structures, more than likely this scenario will include a portion of the land in the sale requiring you to report the sale as two separate transactions and adjust the land allocation on the unit you keep, accordingly. (one sale for the structure, the other sale for a portion of the land.) While a bit of work, it's perfectly doable and, if done right would reduce the land value according for the portion of land you keep, and not mess up your depreciation history on the structure you keep.
- If you have any "personal use" of either structure while it's classified as a rental, it will require a bit of manual math on your part to get the allocations right.
- If you convert only one of the units to personal use and stop depreciation on that unit for a period of time, and then later want to convert it back to a rental, it's not as simple as selecting the option to indicate you converted it from personal use back to a rental. it will "require" some manual math on your part and a completely new entry in the assets/depreciation section.
