Any gain due to depreciation will still be taxed. The $250,000/$500,000 exclusion does not cover that.
@squirrellandlord wrote:
We converted our basement to an in-law suite and are renting it out to a tenant.
Pub 523 states that "if the space you used for business or rental purposes was within the living area of the home, then your usage doesn't affect your gain or loss calculations."
If the basement is it's own "dwelling unit" (for example, its own kitchen, entrance, etc.), that is treated as a separate property and would not be covered by the $250,000/$500,000 exclusion.
