Coastal sage scrub (CSS), a Mediterranean ecosystem of California, is being replaced by exotic annual grasses. Although the mechanism has been related to seasonal fire, vegetation replacement also occurs in stands where fire has not occurred for long periods. Under these conditions nitrogen (N) air pollution may increase soil fertility and accelerate exotic grass invasion in CSS. The aim of this study was to determine the effects of plant species and N on N cycling in soil using a controlled greenhouse experiment. Using a full factorial design, we measured the response of N cycling rates in soil (Net mineralization, net nitrification and potential rates), microbial biomass and activity (Microbial biomass carbon (MBC) and nitrogen (MBN), protease activity and soil respiration) and microbial diversity (using terminal restriction fragment length polymorphism (T-RFLP) of the 16s RNA gene), to plant species (native shrubs Artemisia californica and Salvia apiana, a exotic grass Avena fatua and control with no plant), two N forms (ammonium and nitrate) and two levels of N (15 and 40 µgN/g soil). There were no direct effects of N fertilization on soil variables, though complex interactions were observed. Regardless of N treatment, A. fatua grew more rapidly than the native shrubs, significantly reducing soil water. The lower availability of water in soils under A. fatua explained the reduction of potential mineralization, microbial biomass, and soil respiration. Principal component analysis showed that T-RFLP profiles clustered more strongly by plant species than by N treatment.  A. californica samples had higher soil moisture, potential mineralization rate, and MBN, and these variables were positively correlated to terminal restriction fragments (TRF) of 52-75 bp. In A. fatua samples, TRF of 154-160 bp were more abundant. Hence, invasive plant species may have an overriding effect on microbial community structure and function, particularly through effects on soil moisture.