I understand your points. But I still don't see how any of that refines "taxable income" from the above cited code-wide meaning to be "foreign tax rule calculated taxable income" and why some of the deductions are US and some are foreign by your (and other folks on this forum). No one has cited any authority (code section, regulations or even non-binding guidance like instructions or publications) that makes me question that.
The PAL carryover is not limited to 10 years. https://www.thetaxadviser.com/issues/2017/apr/disposing-passive-activities.html The FTC carryover is limited to 10 years and in many cases will never get used. So for US taxes you won't lose the PAL unless you die owning the property and then you get a step-up in which case you can't complain about any of this (especially if you have no offsetting estate tax).
Technically I believe adjusting basis for depreciation is not "recapture." I think (but don't have time to verify) that recapture applies when upon sale depreciation allowed or allowable is taxed at ordinary income rates (such as when taking accelerated (i.e. not straightline) depreciation or certain types of business property).
[EDIT: This is not correct. Rather the it is taxed at your ordinary income rate capped at 25%. When you adjust basis on rental real estate (maybe with no accelerated deprecation), you are getting a subtle tax break. Your depreciation deduction reduced ordinary income, but you the basis adjustment upon sale taxes you at capital gains rates. That difference can be huge.]
I see what you are saying that when the depreciation comes back perhaps that should be accounted for in the FTC calculation. I think it is. You would have foreign capital gain in that year. When computing the FTC any foreign tax on that gain, as we've discussed, what what matters for the IRC 904 limit is US foreign source income/deductions. Your US foreign source income will be different than your foreign income by foreign tax rules. US income will be more because of the lower basis. That will increase the amount of the FTC because the numerator in the 904(b) calculation will be higher.
On a more general point Supreme Court Cases going way back have ruled that deductions are a "matter of legislative grace." That means you cannot reason that there should be a deduction (or credit). Rather you must find a statute that grants such a deduction. If it isn't there, then even if it should be there for fairness or some other reason, Congress has chosen not to give you that deduction. Congress can tax all of your income from any source and need not give any deductions. https://supreme.justia.com/cases/federal/us/305/281/#:~:text=Every%20deduction%20from%20gross%20inco....
I wonder if people are seeing what they think should be deductible on 1116 part I line 2 rather than finding authority for what should be deductible there.
But again I could be wrong. I'm not sure I'm right, I just still haven't seen anything that moves me the other way.
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