First-year depreciation on the same short-term rental: $202,956 on the federal return versus $41,956 on the California return
In short: mostly, yes. California’s passive loss rules generally follow federal law, so a short-term rental with an average guest stay of seven days or less, in which you materially participate, can generally produce a loss that offsets your wages on your California return too. Two things change. California doesn’t allow bonus depreciation, so the first-year loss on your state return is usually far smaller. And California never adopted the real estate professional exception, so REPS does nothing for you at the state level.
Most STR loophole advice is written for the federal return. If you live in California, your rental shows up on two returns, and they don’t tell the same story. In the example below, a San Jose couple reports a $193,000 loss to the IRS and a $32,000 loss to the Franchise Tax Board — same cabin, same year, same hour log. Here is where the two returns part ways, and what that means for your plan.
Does the STR loophole work in California?
Generally, yes. California adopts the federal passive activity loss rules, and the Franchise Tax Board’s instructions for form FTB 3801 say California law is generally the same as federal law on passive losses. The difference they single out is the special treatment of real estate professionals.
The short-term rental route doesn’t depend on that special treatment. It rests on the federal regulations that define a rental activity: when the average period of customer use is seven days or less (or 30 days or less with significant personal services), the property isn’t a rental activity, so it isn’t passive by default. Whether its loss is passive then turns on material participation — the same seven tests, counting the same hours, on both returns. Our STR loophole guide covers the federal rule and how to calculate your average stay.
The FTB’s instructions don’t address short-term rentals separately, so confirm the treatment of your property with a California CPA before you rely on it, especially if your average stay sits close to seven days.
Why REPS doesn’t help on your California return
Federally, a real estate professional who materially participates can deduct long-term rental losses against other income. California never adopted that rule. In the FTB’s words, “For California purposes, all rental activities are passive activities.” The federal election to treat all your rentals as a single activity doesn’t apply on the state return either.
So a couple who qualifies for REPS can deduct a long-term rental loss federally while the same loss is suspended in California, carried forward on form FTB 3801 until there is passive income or the property is sold. For Californians, that makes the short-term rental route the more useful one at the state level: a property that averages seven days or less isn’t a rental activity at all, so the “all rentals are passive” rule doesn’t reach it. Our REPS guide explains the federal tests.
The bigger difference: no bonus depreciation
The law signed on July 4, 2025 made 100% bonus depreciation permanent for eligible property acquired after January 19, 2025. California doesn’t follow it: the FTB lists additional depreciation under IRC Section 168(k) among the federal and state differences reported on form FTB 3885A. On your California return, the same assets are depreciated on the regular MACRS schedules instead. Five-year property such as furniture gets 20% in the first year under the half-year convention, and 15-year land improvements get 5%.
A cost segregation study still helps in California, because shorter-lived components are written off faster than the 27.5-year building; it just helps much less in year one. California does allow Section 179 expensing, but caps it at $25,000 for 2025, reduced dollar for dollar once qualifying purchases exceed $200,000. Whether a vacation rental’s furnishings qualify depends on the rules for property used for lodging, so ask your CPA.
Nothing is lost over time. Total depreciation is the same on both returns; California spreads it over more years. The deductions you don’t get in year one show up as larger California deductions in the years that follow, and because your California basis stays higher, your California gain is smaller when you sell.
A side-by-side example
Maya and Dev live in San Jose, file jointly and earn $380,000 in W-2 wages. In March 2026 they buy a $750,000 mountain cabin in California — $150,000 of it land — and spend $40,000 on furniture. A cost segregation study moves $90,000 of the building into 5-year property and $60,000 into 15-year land improvements, leaving $450,000 on the 27.5-year schedule. Guests stay three nights on average, Maya and Dev log 160 hours between them, and their cleaner logs about 110. Before depreciation, the rent covers the mortgage interest, property taxes and operating costs with $10,000 to spare.
First year (2026) Federal return California return
Furniture and 5-year components ($130,000) $130,000 (100% bonus) $26,000 (20%)
15-year land improvements ($60,000) $60,000 (100% bonus) $3,000 (5%)
Building, 27.5 years ($450,000, from March) $12,956 $12,956
Total depreciation $202,956 $41,956
Rental result before depreciation +$10,000 +$10,000
Loss from the cabin −$192,956 −$31,956
Approximate tax saved for 2026 About $45,200 About $3,000
The federal loss moves part of their taxable income from the 24% bracket down into the 22% bracket; the California loss stays inside the 9.3% bracket. Had California followed bonus depreciation, the state loss would also have been about $193,000, worth roughly $17,900 on their California return. The difference, $161,000 of depreciation, isn’t gone: California deducts it over the following years. Try your own federal numbers in the STR loophole tax savings calculator, then ask your CPA for the California schedule.
Other California differences to plan for
Excess business losses: California has its own limit, figured on form FTB 3461. For 2025, net business losses above $313,000 ($626,000 on a joint return) are disallowed and carried forward as an excess business loss rather than a net operating loss. For the federal limit, see our article on the STR loophole income limit.
Two sets of numbers: because depreciation differs, you carry separate federal and California depreciation schedules, basis and passive loss carryovers for each property. Ask for both schedules when you order a cost segregation study.
A rental in another state: California taxes residents on all their income, so an out-of-state rental appears on your California return with California depreciation. If the property’s state has an income tax, you may also need to file a nonresident return there; California generally gives residents a credit for tax paid to another state on the same income.
When you sell: California has no lower capital gains rate, so the gain is taxed at ordinary rates of up to 13.3%. Because you deducted less depreciation in California, your California gain is usually smaller than the federal one. Our article on depreciation recapture covers the federal side.
What to keep for both returns
The hours are the one thing that doesn’t change between returns. The same contemporaneous log proves material participation to the IRS and the FTB: date, property, task, actual minutes, who did the work and the evidence behind it, plus the hours of anyone else who works on the property. Keep your booking records to prove the average stay, both depreciation schedules, and your copies of forms FTB 3885A and FTB 3801 each year.
Our free material participation log template has a tab for other people’s hours, and the PropHours app logs by timer, voice or receipt scan and gives your CPA read-only access to the same records. If you have a day job, start with our STR loophole playbook for W-2 employees.
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