AARP Foundation Tax Aide tax preparer here, so I theoretically train on and know some of this stuff. Lots of misinformation on this thread, which I'll try to correct:
1. Regardless of what your renter is doing and who is paying you, it's rental income to you, and unless it's less than 14 days (Augusta rule), must be reported on your tax return.
2a. If you came in to use our services and mentioned the rental income to me but said you didn't want to report the income, I would immediately stop the process, inform you it was tax fraud, and refuse to prepare your return. I also would not help you in any way other than to encourage you to report all income. In fact, I had to do that to someone last year who came in and mentioned some income but didn't want to report it. Even if the amount is only $1. Any quality tax preparer would, I think, do the same.
2a. I wouldn't trust anyone who is willing to help you commit tax fraud to prepare a return even semi-properly. In other words, in addition to the rental tax fraud you might compound your problems with other mistakes on the return.
2c. I wouldn't report you to the IRS, but someone else - including a tax preparer, a friend, an acquaintance, or your renter - might. Last I looked, a whistleblower could receive 15% of the taxes collected from a tax fraud.
3. You're not required to take depreciation. However, you will be required to pay depreciation recapture on the depreciation whether taken or not. And depreciation generally reduces current taxes. So most people go ahead and take all the depreciation to which they are entitled.
4. If audited, you can't claim ignorance. And there is the possibility of being prosecuted and jailed for tax fraud. Even if you're a small fish, the IRS might choose to make an example out of someone, and that someone might be you.
5. Note that if you deduct mortgage interest on Schedule E (which I'm not sure, but it seems plausible you could), then you probably can't also double-dip and report that same interest on Schedule A. You'd have to apportion it appropriately between the two schedules.
6. Generally depreciation recapture is taxed at a different rate than capital gains. I believe you'd pay depreciation recapture then also any applicable capital gains when you go to sell.
7. You're confused about the capital gains exclusion. The basic rule is if you own and live in the house 2 of the last 5 years when you sell and have not taken excluded another home sale gain in the past two years *and have not used the house for home office or a rental* then you get the full exclusion, which is $250K for a single person. Having a rental (or home office that you've deducted) will impact the capital gains exclusion. The calculations are rather involved; see Pub 523 for details at
https://www.irs.gov/publications/p523#en_US_2021_publink100077087.
I'd agree with a previous poster - pay someone to do it correctly this year, then learn how to fill out Schedule E yourself.