For the other way, lets consider some realistic numbers based on a longer timeframe.
I purchased my house in 1990 at a cost of $35,000. The house occupies 1,500 sq feet and sits on a lot that is plenty big enough for me to add on to. Let's say 1/3 of an acre. Now of that $35K I paid for the house $28K is what I paid for the structure and $7K for the land. The structure is 3 bedroom, 2 bath, kitchen, dining room and living room. My "cost basis" on the property is $35K at this point.
Now in 2015 I add on another 1,000 sq ft consisting of a kitchenette, bedroom, bath and a laundry room. The addition cost me $50,000. Now by total square footage of my structure is 2,500 sq feet and my total cost basis in the property is $85K with $78K paid for the structure and $7K for the land. (I didn't pay squat for more land... I only paid for more structure.)
If I'm going to rent out what I added on then I figure what percentage of what is basically my primary residence floor space I am going to use for this rental business. I'm renting out 1000 sq feet of my total 2500 sq feet of my structure. 1000/2500=0.4 or 40% of my floorspace.
So in the rental & royalty section of the program I will indicate that "I rent out a part of my primary residence". Then when I get to that point I will enter $85,000 in the "COST" box and $7,000 in the "COST OF LAND" box. I will also indicate the entire property is 40% business use. THe program will do the additional math "for me" in the background and not bother me with the details. Basically, here's how it will work out.
Since land is never depreciable, it doesn't figure into the equation really - even though the program will assign 40% of the $7,000 land value to the rental portion. That comes to $2,800 and the only place you'll see that will be in the IRS Form 4562 that prints in landscape format. (There are two of these forms - one titled "Depreciation and Amortization Report" and the other is titled "Alternative Minimum Tax Depreciation Report")
Then 40% of the structure value will be $78,000 X 0.4 = $31,200 and that is the amount that will be depreciated over the next 27.5 years.
Now whichever way you do this really doesn't matter. But just remember that in the end, what you save in taxes now, you will pay back later, and the payback later will be more than what you may save now.
When you sell the property down the road, all prior depreciation must be recaptured in the year of sale, and you pay taxes on that recaptured depreciation. Now while chances are good that your carry over losses will negate a large portion of that, it all depends on your sale price (thus your taxable gain on the sale). But regardless, the recaptured depreciation *will* increase your AGI for that year and when combined with the taxable gain will most likely put you in a higher tax bracket.
So you can save now, pay later if you like. Or you can save less now and potentially pay less later.
