Thank you very much for your detailed response @jtax.
From the seeming contradiction in the responses I am receiving from two very well versed TurboTax experts, it is clear that this part of the 1116 instructions is vague and not fully understood or uniformly applied. As for background, the CPA who helped me with our return last year, who works for a major tax firm that specializes in expat returns, excluded the depreciation from Line 2. As I am doing our return myself this year, and being someone who values fully understanding things before doing anything, I wanted to also seek input from experts here before adopting this position once again in this year's return.
In relation to the three points you presented here are my thoughts.
I see where you are coming from in your Point 1, but to me this still does not provide any conclusive evidence one way or another (as to whether the US based deductions or source based deductions should be included on Line 2, 1116).
As for your Point 2, I can see that the reasoning behind the inclusion of this deduction is very different (i.e., to fairly allocate the deduction that applies to the entire taxable income reported in the US return between the foreign and the US sources) than the expenses reported on Line 2.
The section of Pub 514 you are referring to in your 3rd point is the only section where I was able to find such specific example on the application of "deductions" in any of the relevant IRS publications. As you also mentioned, this specifically quotes "...also have deductions of $4,400 that, under foreign law, are not definitely related to either the wages or interest income." To me, this is conclusive and the definition of "deduction" should not be isolated only to the allocation of foreign taxes just because the term was defined in that section.
Based on the above, I am leaning toward the @pk's interpretation for the expenses to be included on Line 2. Many thanks again for your thoughts on this!
