OK, I can now confirm that remote debugging with stepping into your own libraries installed on the cluster is possible and is actually pretty convenient using a combination of databricks-connect Python library and a Databricks extension for VSCode. Setting it up is pretty straight forward as well (everything is documented). Only one part confused me: all your Python code runs locally and only spark code is sent to the cluster. It means that your launch.json might end up looking like this (see below) and you actually need to use a profile related to debugpy (with justMyCode set to false) when initiating debugging session. Hopefully, it helps someone.