In San Diego, you could insulate and drywall without a permit. Installing a window would need a permit, as would ANY plumbing or electrical work.
First, let me say you would be far from the first to "convert" a garage like this. Now let me tell you all the things that are not kosher:
1) Chances are you would violate zoning if you do anything which would prevent a car from being put in the garage. City zoning usually specs. parking requirements on site, and the garage is part of that. Keeping the big door gives you a loophole on that one.
2) You could not legally have sleeping in that space if there is a gas water heater located there.
3) You could not legally install anything resembling a kitchen, as that would be prima facie evidence of a second rentable unit on premise, and that would require a zoning change or conditional use permit.
If you keep a low profile, this kind of thing flies under the radar all the time, unless you have ticked off a neighbor, who will drop a dime on you to neighborhood code compliance. Then, once the city gets interested, the tax man also gets interested.
I recommend keeping everything above board.