It appears (from pub 527) that we are able to claim depreciation on the building value of that portion of the house,
Actually, you're required to depreciate, based on the percentage of space that is "exclusive to the renter".
as well as the money we spent converting the basement.
More than likely those costs are property improvements. Here's where percentages can come into play.Let's talk about the basic structure and land first. Then I'll get into the other stuff.
If 20% of your total floor space is exclusive to the renter, then you're required to depreciate 20% of the total structure value. Now you'll include in your assets/depreciation section say, 20% of your land. But the value of the land won't be depreciated anyway since land is not depreciable.
Let's keep the numbers and the math simple for this example, and say you paid $100,000 for the entire property, with 30% of that cost allocated to the land. Then say you're renting out 25% of your floor space exclusive to the renter.
Twenty five percent of $100,000 is $25,000. But we have to allocate 30% of that $25,000 to the land. So when entering this in the program, you'll enter $25,000 in the "Cost" box and $7,500 in the "cost of land" box. ($7,500 is 30% of $25,000) That means a structure value of $17,500 ($25,000 minus $7,500) will be depreciated over the next 27.5 years.
That takes care of that. Now lets cover your cost incurred in the process of making it a rental and getting it move-in ready for a tenant. For this example, we'll say you spent $10,000 for a new floor, finishing out the walls and ceilings and installing a kitchenette and maybe a bathroom for that tenant. Since all the work was done in the rental portion and for the primary purpose of making it a separately rentalable unit, it can all be grouped together as a single property improvement. Additionally, since this work was done 100% for the rental portion, it's 100% business use. (unlike the initial entry for the entire house which is 25% business use.)
So the cost of your property improvments would be entered as such declaring 100% business use. Now you improved the property - *not* the land. So you would still classify this improvement as "residental Rental Real Estate" with 100% business use. In the COST box enter $10,000 and in the "cost of land" box, enter a zero. The entire amount of $10,000 will be depreciated over the next 27.5 years.
Now take special note since you have two asset entries for this property that are "NOT" the same percentage of business use, it will be up to you (and you alone) to keep track of your total cumulative depreciation as the years pass. That's because when you sell the property you'll be required to recapture all depreciation taken and pay taxes on it in the tax year you sell.
With the type of setup I've "exampled" here it will be easier to report the sale of your house (when that day comes) in the "sale of business property" section, than it will be elsewhere in the program. You'll also be able to get a partial credit for the "lived in 2 of last 5 years" too, if you qualify.
