Does California recognize real estate professional status on Form FTB 3801? Federal real estate professional status can make rental losses nonpassive on your Form 1040. California does not follow that rule. The Franchise Tax Board's 2025 Instructions for Form FTB 3801 say California did not conform to IRC section 469(c)(7). For California purposes, all rental activities are passive activities. The federal REPS election and grouping under that provision do not apply to the California return.
If you live in Los Angeles and qualify for REPS federally, plan for two different answers: a federal loss that may offset W-2 wages, and a California rental loss that often stays suspended on Form FTB 3801 until you have California passive income or dispose of the activity.
For the federal REPS stack, start at REPS and passive losses. For material participation language, see material participation vs active participation.
What FTB says in plain English
From the 2025 Instructions for Form FTB 3801, under "Material Participation in Real Property Business - IRC Section 469(c)(7)":
- Beginning in 1994, and for federal purposes only, rental real estate activities of taxpayers engaged in real property business are not automatically treated as passive activities.
- California did not conform to this provision.
- For California purposes, all rental activities are passive activities.
- An election under IRC section 469(c)(7) is inapplicable for California personal income or franchise tax.
- Taxpayers should group rental activities without regard to IRC section 469(c)(7).
That is the core nonconformity. Do not file California as if Schedule E line 43 REPS reporting copied over automatically.
What still works the same (and what does not)
| Item | Federal | California (per FTB 3801 instructions) |
|---|---|---|
| REPS / §469(c)(7) | Can turn off automatic rental-passive treatment for the year | Does not apply. Rentals stay passive activities for CA |
| §1.469-9(g) rental grouping tied to REPS | Available when you qualify | FTB says group without regard to §469(c)(7) for CA |
| $25,000 special allowance for active participation | Available subject to MAGI phase-out (§469(i)) | FTB instructions still provide the special allowance framework on Form 3801 (same living-apart / filing-separate limits described in the form instructions) |
| Form to compute PAL | Form 8582 | Form FTB 3801 |
| When federal is nonpassive and CA is passive | N/A | Use actual federal amounts allowed in column (d) of the California Adjustment Worksheets (FTB instructions) |
California also has its own depreciation and bonus-depreciation differences. Federal bonus depreciation often does not flow to the California basis calculation the same way. That can make the California loss smaller in early years even before passive-activity limits. See our notes on California bonus depreciation nonconformity.
What an LA investor sees on the two returns
Federal return (REPS year, simplified). One spouse meets both REPS tests. You materially participate in the rental activity (or the grouped activity). Basis and at-risk rules allow the loss. The loss can offset W-2 and other nonpassive income, subject to the excess business loss limit.
California return (same year). The rental activity remains passive for California. The loss that freed up federally is often limited again on Form FTB 3801. Suspended California passive losses carry forward. You may need California Adjustment Worksheets on Form FTB 3801 when the same Schedule E activity is nonpassive federally and passive for California. The FTB instructions expressly call out rental real estate professionals for that worksheet treatment.
Net effect for many high-W-2 California households: federal tax drops in the REPS year, California taxable income does not drop by the same rental loss. Cash-tax planning has to look at both estimates, not only the federal projection.
Short-term rentals and California
The federal short-term rental exception under Temp. Reg. §1.469-1T(e)(3)(ii) is a federal passive-activity characterization rule. California passive-activity results still run through Form FTB 3801 and California amounts. Do not assume a federal STR material-participation win clears California automatically. Compare the federal position on our REPS vs short-term rental exception page, then model California separately.
Local Los Angeles short-term rental registration and zoning rules are not tax conformity questions. They are local law. Fail those and the tax theory does not save the listing.
Form FTB 3801, without the software mystery
Individuals, estates, trusts, and S corporations use Form FTB 3801 to figure allowable California passive activity loss and the adjustment between California and federal PAL.
You generally file it when you have losses (including prior-year unallowed losses) from passive activities. The instructions describe a narrow exception when your only passive situation is a rental real estate loss fully deductible under the special allowance and you have no other passive activities.
Practical sequence the instructions describe:
- Build California income or loss for each passive activity before PAL limits (California Passive Activity Worksheet), including depreciation differences when needed (Form FTB 3885A).
- Complete Form FTB 3801 Side 1 using the federal Form 8582 mechanics as a guide, with California amounts.
- Allocate allowed and unallowed losses by activity.
- Push results to California schedules or the California Adjustment Worksheets, then to Schedule CA (540) or (540NR).
Nonresidents and part-year residents complete the form and worksheets twice under the FTB instructions (all-source resident view, then California-source / part-year view). That matters for investors who leave California or keep California rentals after a move.
Excess business loss is another CA fork
Form FTB 3801 instructions also discuss California treatment of excess business losses and Form FTB 3461. California conformity to federal §461(l) history is not identical in every year. After at-risk and passive limits, California may still limit business losses under its own thresholds and carryover rules. If you stack REPS, cost segregation, and a large federal loss, ask for a California EBL check in the same planning memo. Do not stop at Form 8582.
Common filing mistakes we see
- Copying federal nonpassive rental treatment onto California Schedule E with no Form 3801 analysis.
- Treating the federal §469(c)(7) grouping election as a California election.
- Forgetting suspended California PAL carryforwards when the property sells in a later year.
- Projecting only the federal refund from cost segregation and REPS, then underpaying California estimates.
- Assuming the $25,000 allowance is gone in California because REPS applied federally. Active participation and REPS are different concepts. Model the allowance on California rules when it still applies.
Frequently asked questions
Does California recognize real estate professional status?
Not the way the federal return does. FTB's 2025 Form 3801 instructions state that California did not conform to IRC section 469(c)(7) and that all rental activities are passive for California purposes.
If I qualify for REPS federally, can I deduct the same rental loss on Form 540?
Often no, not in the same year. The loss may be allowable federally and still limited as a California passive activity loss on Form FTB 3801, then carried forward.
Do I still file Form FTB 3801 if my federal Form 8582 shows no passive loss?
You might. When an activity is nonpassive federally and passive for California, the FTB instructions tell you to use the California Adjustment Worksheets and to put actual federal amounts allowed in column (d). Your software may still need Form 3801 even when federal 8582 is small.
Does California allow the $25,000 active-participation rental allowance?
Form FTB 3801 still includes the special allowance structure for rental real estate with active participation, with the married/RDP filing-separate limits described in the instructions. It is separate from REPS. High MAGI can still phase it out.
What about the federal grouping election on my California return?
FTB says taxpayers should group rental activities without regard to IRC section 469(c)(7) for California. Do not assume the federal REPS aggregation statement controls the state return.
I am a part-year California resident. Is this worse?
It is more paperwork. The FTB instructions require nonresidents and part-year residents to complete Form 3801 and the worksheets twice with different source assumptions. Get that modeling done before you move mid-year with large rental losses.
Talk it through with us
Bring last year's federal Form 8582, California Form 3801 if you filed one, a property list, and whether you are claiming federal REPS or a short-term rental material-participation position. We will map the federal and California outcomes side by side. Book a new client intro.
LaviCPA is a Los Angeles CPA firm for real estate investors. Shawn Lavi, CPA, is the firm's principal. Elias Lavi, CPA, is its founder and co-owner.