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.

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@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."

 

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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.  

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.

in addition, if you are renting out to a relative at less than FMV your deductions will be limited to rental income. 

money spent converting would not be a deductible expense but a capital one subject to depreciation,

when you take depreciation on your home whether for home office or because a part was rented, depreciation recapture comes into play. 

Can someone plz help me.

I am renting a room within the living area, do I need to depreciate?

according to pub 523 when selling your home

Exceptions. The following situations of business or rental usage don’t affect your gain or loss calculations.
• Space within the living area. 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. Examples of spaces within the living area include a rented spare bedroom and attic space used as a home office. In contrast, business or rental spaces not within the living area affect your gain/loss calculations. Examples of space not within the living area include a first-floor storefront with an at- tached residence; a rented apartment in a duplex; or a working farm with a farmhouse on the property.
• Space formerly used for business or rental. Space that was once used for business or rental pur- poses may be considered as residence space at the time of sale. A space formerly used for business is
Worksheet 2. How To Figure Your Gain or Loss
considered residence space if ALL of the following are true.
– You weren’t using the space for business or rental at the time you sold the property,
– You didn’t earn any business or rental income from the space in the year you sold your home, and
– You used the space as residence space for 2 years out of the 5 years leading up to the sale.
If your space is considered as residence space at the time of the sale, then your former business usage DOESN’T affect  your gain/loss calculations, unless you took or were allowed to take depreciation for use of your home for business or rental purposes. See Worksheet 2, line 5

and line 5 is states the following 

Any depreciation you took or were allowed to take for use of your home for business or rental purposes