I'm not a fan of pigeonholing - it divides and excludes when we should be including, and it may stop people from finding books they'll like (though that'd be their own fault I suppose for not trying a book that has a different label on it. But still) And of course, as noted above, many books fall into more than one sub genre. So if you label your book magical realism, when it's really that, plus lots of UF, plus a bit of S&S, well someone who doesn't like magical realism won't even try it, even though they'd love it if you called it UF.
Where we seem disagree most, at this point, and which I think you got at only subtly(so I hope I am not reading you wrong), is whether or not Magical Realism is a sub-genre of Fantasy or not, and whether this matters.
I don't think it is. The roots and influences are different, the styles are different, the readership is different, expectations are different. A sub-genre of a genre is a spin, or reaction to it, or even a focusing. Urban-Fantasy, High-Fantasy, Low Fantasy, whatever you want, they are clearly derived from 'fantasy'. It is rare to see Magical Realism influenced from Fantasy. I would argue Sci-Fi is far more influenced by Fantasy, and is rightfully placed next to Fantasy, when compared to where Magical Realism is placed.
Magical Realism runs in parallel to Fantasy, distinctly. They both came about around the same time, but born from different places. Kafka was an early precursor to Magical Realism, and then later the South American authors came and essentially (re)created it. It's about examining the modern world through allegory, through tradition, through history. It's what I consider a 'searching' genre, more interested in a reader looking for something, as opposed to a reader who wants to be taken somewhere.
Fantasy(modern I guess) came from Tolkien, and a sense of creating a new world to escape to within literature, where seemingly anything can happen. They are like fairy tales, meant to pull readers out of the every-day. It's goal is, for me(obviously), totally different from the goal of Magical Realism.
So your argument about sub-genres over-complicating categorization, holds true; but I don't see how it can be an argument against Magical Realism. They sit at opposite ends of the book-store, in different sections, where-as in comparison Urban Fantasy(a true sub-genre) clearly has a place on the same shelf as Fantasy.
There is little cross-readership simply because the two genres are so different. Someone who reads Tolkien, will probably find more enjoyment going to Science-Fiction, or the Thriller section, than the Magical Realist section(if this section ever even exists). I encourage people to read all of them, but I think your argument for labeling Magical Realism as Fantasy, simply to spur on readers is hugely flawed. If they want to read Magical Realism, it won't be because they want more fantasy, it will be because of another drive or interest.
As for your issue with pigeonholing--that is something entirely out of our control, if a reader isn't experimenting because of over categorization, that is because of their own insecurities. Not really an issue worth talking about here.
Edit: I just re-read this, and I hope I don't come off as overly aggressive or negative; it is an interesting discussion for me and I don't want to come off the wrong way.