...... and I will have to install a full
subfascia against either along the rafter tails (but this would add to
the width of the soffit), or block them up between the rafter tails
(would keep the original soffit width, but not sure about the strength),
or cut the rafter tails and add the subfascia.

Now the next question is - what do I used for subfascia - they
recommened 2x lumber, but do I use regular wood, pressure-treated, or
that synthetic wood like they use for decks (Miratek)?

We use regular pine 2x along the tails and usually cap it with cedar facia.