I also pointed out that her mom had owned the house for about 15 years and probably had a basis of about $135,000 and with the stepped up basis she could sell now with no capital gains but if she rented it for a couple of years she would lose that benefit.

Why wouldn't you want to defer, reduce or entirely eliminate any unrealized capital gains tax?

Chris, you say you have $100K equity but you don't mention how much gain you have.

I know there may be a tax on the capital gain, anything else could become an issue?

@Cody EvansGet that website up and running would be definitely a first. you're going to want to be able to send people to your website where they will be able to gain more information about you, check credibility, etc.... 

I'm ahead around 6x (pre-capital gains tax) on my initial investment in the form of equity (down payment and closing costs only), and tenant has paid a years worth of mortgage as well.

Rent the downstairs new addition (can be 2 bedroom) out for more, since it's bigger and no longer in the basement and is fully legal as a secondary unit (~$2200, 800sf)What would you do?

The engineer report will legally protect you. 

If I sell my home, I would have approximately 220K in gains to use.Can anyone suggest the best approach when considering using one's leverage in home for investing? 

Am I exposed to any legal liability currently?