My ADU on my primary residence is rented. Can I 1031 the ADU portion when I sell?

An ADU with its own kitchen and bath is a separate portion that the exclusion does not reach

The exclusion applies to your dwelling unit, a term Reg. section 1.121-1(e)(2) takes from section 280A(f)(1) while excluding appurtenant structures. A detached cottage or a converted garage with a kitchen, bathroom and sleeping space is a second dwelling unit, and gain allocable to it is excluded only if you met the two-year use test for that part.

The regulation's own Example 3 is a basement apartment with a kitchen, bathroom and separate entrance, rented to tenants. The owner allocates the gain and recognizes the apartment's share, including its depreciation.

If your rental space is instead a room or suite inside the house, Publication 523 says no allocation is needed and the exclusion reaches the whole gain except depreciation. That case is treated in the home-office portion.

The IRS's guesthouse example shows the house excluded and the second unit exchanged in one sale

In Example 2 of Rev. Proc. 2005-14 a taxpayer owns a house and a guesthouse that are separate dwelling units, lives in the house and uses the guesthouse for business, allocating two-thirds of basis to the house by square footage. On the sale, the house's $100,000 gain is excluded.

The guesthouse's $80,000 gain, after $30,000 of depreciation, is deferred under section 1031 because the replacement business property equals the fair market value of the relinquished guesthouse and no boot is received. A rented ADU fits the same pattern, since section 1031(a) treats property held for investment and business property alike.

Allocation follows Reg. section 1.121-1(e)(3): the same method you used for depreciation, with square footage accepted. Where the ADU was built years after you bought, its basis is its construction cost plus any land you allocated to it, so agree the method with your CPA before listing.

Worked example: a $1,200,000 sale with $300,000 allocated to the ADU

Hypothetical, round figures, selling costs ignored. A married couple sells for $1,200,000 and allocates $300,000 to a rented backyard ADU. Its basis is $200,000 less $30,000 of depreciation taken on a 27.5-year schedule under Publication 527, so $170,000.

ADU gain: $300,000 less $170,000 is $130,000, of which $30,000 is unrecaptured section 1250 gain at up to 25% under Topic 409. House gain: $900,000 less a $400,000 basis is $500,000, all excluded on a joint return.

Send the ADU's $300,000 to a qualified intermediary and buy at least $300,000 of investment real estate, and the $130,000 is deferred. The replacement's basis starts at $170,000. Run your own numbers with your CPA.

The ADU money has to buy investment property, not your next home

Replacement property must be held for investment or business use, so the ADU share cannot go toward the house you move into. Buying a property that you will partly occupy raises its own allocation, covered in 1031 into a property I partly live in.

Exchange rules apply in full to the ADU share: identify within 45 days and close within 180 under Reg. section 1.1031(k)-1, keep the proceeds with the intermediary, and replace the ADU's share of any loan paid off. Missing part of the target makes it a partial exchange; see what boot is.

The Form 8824 instructions handle a property used partly as a home with two worksheet forms combined on the one you file, and the house share goes on Form 8949 and Schedule D only if part of it is taxable.

An ADU-sized amount is where a fractional interest earns its place

The ADU share of a sale is often too small to buy a good standalone rental with sensible leverage. A beneficial interest in a Delaware Statutory Trust, which Rev. Rul. 2004-86 allows as replacement real property, can be sized to that share and needs no management.

Trust interests are illiquid, carry sponsor fees and depend on the property's tenants and debt; read the offering documents before you identify one. See traditional DST solutions for how they are used as replacements.