I am using TurboTax online to claim a foreign tax credit for income tax that I paid abroad on my foreign rental income, and I have some doubts on how the software allocates the standard deduction under Part 1, line 3.
Assume that my adjusted gross income is 100k, of which 95k from a W-2 and 5k of "net" rental income from Schedule E (i.e., after deducting expenses and depreciation). Assume also that the total rental income (including expenses and depreciation of 20k) is 25k.
On Form 1116, in Part 1, line 3, TurboTax allocates the standard deduction of 27,700 based on a gross foreign income of 25k (line 3d) out of a gross income for all sources of 120k (95k+25k) (line 3e), which corresponds to a 20.8% share. This gives a result for line 3g of 5,770. This effectively more than offsets the net rental income of 5k, leaving me with a negative value on line 7, i.e., with no foreign tax credit that can be claimed.
This sounds a little unfair, as the net rental income is only 5% of the adjusted gross income (5k out of 100k), yet it is assigned 20.8% of the standard deduction. Because adding this net rental income to my adjusted gross income increases my U.S. tax liability, I feel like I should be able to claim a credit for this additional liability. Am I doing something wrong or is this just how it works?
