Re: When renting out a room, is depreciation still subject to recapture? What about capital gains?
Any gain due to depreciation will still be taxed. The $250,000/$500,000 exclusion does not cover that.
Thanks @AmeliesUncle, this is a really helpful clarification. And as I understand it, this tax applies regardless of whether we actually deducted the depreciation.
It also appears that the rate applied to depreciation recapture is typically 25%, which would be higher than the marginal rate we would pay now if we were not to deduct depreciation. Is that correct? It seems surprising that the net effect of claiming depreciation could be to pay more in taxes overall.
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.
How can I learn more about this? In pub 523, under Business or Rental Use of Home, "space within the living area" is defined without reference to "dwelling units". Instead, it gives some examples:
"Examples of spaces within the living area include a rented spare bedroom […]. Examples of space not within the living area include a […] rented apartment in a duplex".
If it's the case that: i) We must ultimately pay a (somewhat) higher tax rate on the depreciation, which we are effectively required to take; and
ii) We must pay capital gains tax on ~25% of our house (the basement), as a result of having rented it out; and
iii) We cannot apply a loss from the rental 'business' (which I foresee, since the apportioned mortgage interest and depreciation could exceed our rental income, esp. with covid) to our personal taxes, such that our personal taxes also go up (vs. applying 100% of the mortgage interest and property tax deductions to our personal taxes); and
iv) Our taxes also get considerably more complicated
then renting out the basement becomes really quite unappetizing…!