Investors & landlords

@Stsxoz 

Thank you for detailed response and for providing some background.

If you had professional advice from a CPA with significant ex-pat experience (especially with foreign rental or business income -- not just people living overseas), then I think doing it the same way the CPA did it is reasonable. Might or might not be right, but it would seem to be a good-faith attempt to get it right (as opposed to making stuff up). [Of course if wrong and the IRS were to challenge you would of course, always owe the tax and interest, but not penalties because of reasonable reliance on professional advice.]

Back to the substance. 

 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

Yes, that is the issue. But you have to figure out who has the "burden of proof" here. I think that what I referenced is the definition of the words used in I.R.C. 904(a)/1116. It is up to you (or the proponents of the "foreign deduction" theory) to show why the same words used in 904 have a different meaning than they do everywhere else in the tax code. And indeed why they mean something different on 1116 part i line 2 and line 3. 

>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.

Yes that is true. But it makes no sense to me (absent ANY authority) why the country of the deductions would be different? The difference between 2 and 3 is whether the deduction only applies to the income category or must be prorated. Not whether it is a US or foreign deduction. If it were different why would you deduct a share of the US standard deduction to get a net foreign income? That would be irrelevant. It would be the foreign standard deduction (or equiv). 

My point is that it seems to me (absent authority I haven't seen) that  I.R.C. 904/1116 is not computing foreign net income per foreign tax rules. It is computing US income from foreign sources using US tax rules.

Then it calculates the ratio of that to worldwide US-taxed income times the the actual foreign tax paid on the US foreign source income. Figuring the foreign tax actually paid (or accrued) is the only place the foreign tax rules (deductions, etc.) comes into play.

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.

Sorry but I don't buy that. That discussion is talking about allocating the foreign TAX (among categories of foreign income. To do that you must follow the same procedure that I.R.C. 904/1116 does for allocating US deductions to US income from foreign SOURCES. The algorithm is the same but it is applied to different inputs to obtain a different output.

Sorry to be a pain here, but I just don't see it the same way. I could certainly be wrong, but I have seen no authority that budges me.