I am converting my attached 2 car garage to a home theatre and entertaining space. The room is already drywalled but the problem is the foundation comes up about 3 feet up one one side of the room and about 18" on the other side. The current drywall begins on top of the foundation. I want to clean this up and am wondering what the best solution is. Do i just frame up new walls that cover up the foundation? Or can I fur it out? (I think that's basically framing new walls with 2x4's split in half?) Will I need to insulate the new walls since the exterior walls are already insulated?

You could build a "wainscot" cap for the foundation that is the same height all around the room. Build it to chair rail height and add molding at the top. I would insulate to quiet the cavities.

You could just build walls inside the other walls. (see the Sandman's build)

I will probably just frame in some new walls. I like the wainescott idea but the foundation already sticks out about a 1/2" past the drywall above it. I'm not sure I would want it to stick out any more. New walls will be a much cleaner look plus I'll be able to run all of the new wires and everything exactly how I want.