“1. If I claim depreciation on 2011, I show -ve AGI. In Turbo tax there is no option to stop depreciation. Can I stop claiming depreciation in 2011 as it does not give me benefit and when I sell the house I have to account for it ?”--->You don't have a choice in the matter. If, in the future, you sell the property, you will be treated as if you did claim the depreciation even though you decided not to claim it.ALSO, If you realize a long term capital gain on the sale of your rental property (as long as yu have NOL carry over/LTCL, then, no problem), you probably won't get the benefit of the special capital gains tax rate on the entire amount of your gain. If you have a capital gain on any depreciable personal property other than real estate, you must report all or part of the gain as ordinary income,25% tax rate, to reflect the amount of depreciation under Recapture of Depreciation rule. You can carry over passive activity losses incurred in your rental property to offset other Passive activity income overseas (if yu have); In general, passive activity losses can only offset passive activity income, and passive activity tax credits can only be used against tax attributable to passive activity income on your tax return. Any disallowed passive activity losses and passive activity tax credits are tax deferred until passive activity income is generated or the passive activity is disposed of in a taxable transaction. So, UNLESS there is LTCG on the sale of your rental property, you ‘d not be able to deduct your PAL carried over from previous years.
“2. Different topic: Do I need to file state taxes since the house I own is in IL ? I was told if I am filing Fed, I need to file state as well.”--->Correct; as long as your state imposes income tax to its residents; a total of 41 states impose income taxes. You can claim your foreign tax credit(UNLESS you claim your FEIE) on your federal and state returns; however, you do not fully(never) claim your foreign capital gain tax that you pay to foreign taxing authority(ies) on your state return.