Capitalization of most words should follow the standard rules for the English language. A few notable points are:
In sentences, the first word and any proper nouns should be capitalized.
Ellipses can occur both in the middle and at the end of a sentence, so you should check whether the first letter of a clause following ellipses will need capitalizing.
When quoted material is a complete sentence, capitalize the first letter of the direct quote, even if the quote begins in the middle of a sentence. However, do not use a capital letter when the quoted material is a fragment or a piece of the original sentence.
In titles and subtitles, all words should be capitalized except for lowercase articles (e.g., "a," "an," "the"), coordinating conjunctions (e.g., "and"), and prepositions of four letters or fewer (e.g., "of," "from"). Each word in a hyphenated title should be treated as a separate word and capitalized according to the same rules.
Compass points should be lowercase unless part of a title or proper place (e.g., "due north" and "northwestern Ashlands," but "West Gash").
However, there is no universal, ironclad rule for how proper names formed in whole or in part from category nouns are to be governed. Also, Elder Scrolls games have historically differed on their handling of capitalization. Take "the Arcane University," "the College of Destruction," "Great House Hlaalu," "the Buoyant Armigers," and "the King of Morrowind" as examples: writers may differ considerably on how "House," "the University," "the Buoyant Armigers," and "the King" should be capitalized in isolation; and is it "destruction" magic or "Destruction" magic?
In Skywind, we use the following hard-and-fast rules:
All formal ranks and positions (including those not attainable by a player) should be capitalized (e.g., the Imperial Legion rank “Knight Protector,” and the Ashlander tribal position of “Wise Woman”). However, terms for less formalised social roles, in-game classes, and informal titles should be lowercase (e.g., the game class of “knight,” or the job title of “netch herder”/“netchiman”). Note that “Buoyant Armiger” and “Ordinator” are ranks, as well as also being the names of their organizations -- therefore, references to “the Ordinators” or “the Buoyant Armigers” must always be capitalized.
"Great House(s)" and "House(s)" should always be capitalized, as this prevents confusion: a Great House is a Dunmer institution, of which there are a finite number; a "great house" is a superb abode. The name of a House is always capitalized in every context, as it is a proper noun -- e.g., "Hlaalu retainer."
Singular phenomena such as “the Blight” should be capitalized; however, commonplace things related to these things should be lowercase, such as “blight diseases” (and their individual names).
The Arcane University may be termed "the University" in prose when referring specifically to the institution.
Capitalize the proper noun of the formally-constituted Colleges of Magicka, e.g., "College of Destruction;" in all other usage magic and its effects should be lower-case, e.g., "destruction magic" and "absorb fatigue".
Outside of prose, items should be capitalized as if they were a title, so one would pick up "Netch-Leather Boots" but describe them as "netch-leather boots" in the item description. Of course, basic capitalization rules still apply to items: one would not find a "Scroll Of Fireball," but rather a "Scroll of Fireball."
The main divisions of humanoids and their common alternatives, such as "man," "mer," and "elf," should not be capitalized unless they occur at the beginning of a sentence, or in other instances where grammar dictates that they should be capitalized.
When referring to the races that are members of these divisions, they will always be capitalized. This includes all races of elf, all races of men, the beast races (Argonians and Khajiit) and all of the "civilized" mortal races known to exist, such as Imga, Kothringi, Sload, and Tsaesci. All versions of items that include these racial descriptors should likewise be capitalized, such as "Dwarven armor," "Orcish sword," and "Falmer shield," but not "elven dagger."
The term "Daedra" refers to all of the creatures of the realms of Oblivion, both great and small. As the category is so broad, writers in previous Elder Scrolls games have struggled with which set of rules to apply -- should Daedra be grouped with sentient mortals or beasts? Or some with one, and some with the other? This has led to somewhat inconsistent capitalization throughout various games, including of the word "Daedra" itself!
In Skywind, we have opted for the most common capitalization scheme found in Elder Scrolls games: the word "Daedra" should be capitalized, but individual species of Daedra should not, even those who may be seen as intellectual peers of the mortal races, such as dremora. Note that the correct way to capitalize the arachnid denizens of Oblivion is therefore "spider Daedra," not "Spider Daedra."
In a further twist, in-game texts mention that in traditional Tamrielic usage, "Daedra" is the plural form of "daedroth." However, that formulation is stated to be archaic by the Third Era, and furthermore differs from the common usage in all TES games since Morrowind. "Daedra" should therefore be used as both the singular and plural form when referring in general to creatures who dwell in the planes of Oblivion; when referring to the crocodilian species of Daedra, "daedroth" is the singular form and "daedroths" is the plural form (both lowercase).
Lastly, as well as these lesser species, "Daedra" is often used as a synecdoche for various extraplanar deities who are more correctly referred to as "Daedric Princes." Note that, in this instance, both words are always capitalized for the sake of clarity. In Skywind, "Daedric Princess" is never correct, even for Daedric Princes generally considered to be female.
As with Daedra, the names of non-sentient beings and culturally-othered "monsters" like dreugh, rieklings, and goblins are not capitalized.