Method 1 is far from correct (unless you have a zero balance in traditional IRAs at year end) but method 2 doesn't correctly describe the calculation either. The required calculation is done on Form 8606. Generally, the proportion of the distribution that is non-taxable is your basis in nondeductible traditional IRA contributions divided by the sum of your year-end traditional IRA balance plus the amount of your distributions during the year.
To cause TurboTax to prepare Form 8606 , after entering the Forms 1099-R reporting the distributions click the Continue button on the Your 1099-R Entries page, indicate that you made nondeductible traditional IRA contributions, enter or confirm you basis from contributions prior to the current tax year (the amount from, usually, line 14 of your most recently filed previous Form 8606), and your year-end balance in traditional IRAs.
