According to this you may build up to two ADU's on a multi-family property.This is my interpretation of the law and may not be correct.

You never know how what you say is going to be interpreted by outside observers.

As I read the statute, I do not interpret pre-paid rent (ie last month's rent) to be the same as a security deposit. 

Well, I personally don't like to make interpretations and assumptions.

-She paid rent for Feb already so I interpret that to mean she needs to be completely out by the end of March. 

You can request help on interpreting any of the rules on BP, but for the definitive answer, email ADU@ the HCD domain (BP does not permit email addresses). 

The HCD has created this summary sheet for their interpretation. 

When you give a family member below market rent, you're actually "gifting" them the difference (again a CPA interpretation may be different), but that's an expense that you can't deduct (unless your CPA can put a value on it).

However, two of our neighbors had the exact opposite interpretation and they were not happy when we started to rent out our house.

Tony Your interpretation is spot on and correct.Individual banks, lenders, and even loan officers, are allowed to impose additional restrictions that are more conservative than what Fannie allows.