@Kiki , took me a little to get back to you .
A quick look at the figures that you provided says that TurboTax is correct in increasing your foreign tax credit by three fold when you entered the foreign earnings from your rental ( which were no taxed by Japan but is being taxed by the USA and is indeed foreign income). Here is the back of the envelope logic:
Assuming that the basis for foreign tax limitation i.e. allowable for the current year is based on ratio of Foreign earnings for the year to world income ( it actually is a little bit more contorted by if I assume linear tax schedule then rough results will be directionally correct).
(A) Before including the Japan untaxed income :
Foreign income = ( US$324 + US$2060 )= US$2384
World Income = US$45300 + US$2384 = US$47,684.
Thus limitation ratio is 2384 / 47684=4.999%
Total Foreign Tax credit available = US$4632 + US$111=US$4743.
Thus max allowable credit is .0499 X 4743 = US$236.68
(B) After including the Rental income reported on Schedule-E and classing this as foreign income ( taxed or otherwise :(
Foreign income = US$2384 + US$6500= US$8884.
Total world income now is US$45300 + US$ 8884)= US$ 54184.
The limitation ratio is now 8884/ 54184= 16.395% .
Thus the max allowable credit is now .116395 X 4743 = US$777.66
Approx three times.
Now of course many of the assumptions are for purpose of simplifying to get an order of magnitude. The actual figure porbaly will be much lower but the amplification of approx three times is generally maintained.
If you wish I can run the TurboTax with the figures and get a you a better figure. But I am generally satisfied that Turbo is correct.
Also as far as I know there is not stipulation by the IRS that one can only recognize foreign income if , and only if, the income is also taxed by a foreign entity. So it is allowed as far as I can tell.
Is there more I can do for you?
pk
