Investors & landlords

This stuff makes my head hurt. 

You could try it both ways and see if it makes a difference in your FTC. If not don't worry about it.

But what is actually the right thing? 

Simplifying a lot (there are many edge cases that might or might not apply to you) what the 1116 is computing the amount of the FTC allowed. To do that starts with the foreign income (separately in each category). 

Then it reduces that income by deductions. That includes deductions related to that income and a share of general deductions (e.g. the standard deduction). That produces the "net foreign income" (again of that category).

That is used to compute the ratio of that net foreign income to your worldwide taxable (not gross) income (line 18).

This ratio is then applied to your US Tax to reveal the max FTC allowed. (Line 21) You get a FTC of the min(actual foreign tax paid, max FTC).

The idea is that you are finding out how much the US taxed you on that share of income. The max FTC will be what the US taxed you on. If the foreign tax is more, too bad. The idea is not give you a credit for all foreign tax. Rather it is not make you pay twice what the US would charge. Usually you wind up paying more because most the US has such low tax rates.

All that being said, I would think that you should include US depreciation as a definitely-related expense because the US reduces that from your tax on that activity.  However, if you did not claim the depreciation expense on Schedule E (nothing requires you to take a deduction you are entitled to -- show me authority that says otherwise if you know of any), then I wouldn't include it on the 1116 line 2. 

But here's what I think what that would do (mock it up all ways and see/verify for yourself). 

1. It would increase your US tax on the rental. But it would also increase your ratio of net foreign income (now without the US depreciation deduction) to worldwide income and result in a higher FTC.  That might be a wash. (Calculate it both ways and let us know).

2. When you sell the property you must adjust the basis for depreciation "allowed or allowable" so that would result in higher capital gains and/or recapture. It would not matter if you had not deducted the depreciation, you still have to adjust as if you had. That might or might not matter in your situation down the road (e.g. if you are in a low, even zero capital gains bracket at the time of sale, if you don't have a gain even after the adjustment, or if you die owning the property and get a step-up in basis to FMV).

See I.R.C. 1245(2)(A)( "'recomputed basis' means, with respect to any property, its adjusted basis recomputed by adding thereto all adjustments reflected in such adjusted basis on account of deductions (whether in respect of the same or other property) allowed or allowable to the taxpayer or to any other person for depreciation or amortization.") https://www.law.cornell.edu/uscode/text/26/1245 (emphasis added).

https://ttlc.intuit.com/community/tax-credits-deductions/discussion/sale-of-rental-property-deprecia...