California FTB Notice Substandard Housing Forms Request (AUD 1573)

The AUD 1573 is a forms request notice from the California Franchise Tax Board tied to their Substandard Housing audit program. If you received it, the FTB is asking you to submit specific documentation — usually rent rolls, lease agreements, inspection records, or ownership records — related to rental property you claimed on your California return.

California’s substandard housing program targets landlords who receive rent deductions or credits while their properties have been cited for habitability violations under Health & Safety Code Section 17920.3. The FTB cross-references local code enforcement databases, and even a single open citation can trigger an audit letter. Many taxpayers don’t realize a code violation filed against their property automatically flags their return.

At The Reed Corporation, we review these notices carefully before responding. Sending the wrong documents or too much information can expand the audit’s scope. We help clients gather exactly what the FTB is asking for — no more, no less — and respond within the stated deadline to avoid collection action.

Your response to the AUD 1573 must be submitted by the deadline printed on the notice — typically 30 days from the date of the letter. You’ll need to provide the specific forms and records the FTB listed, which often include Form FTB 3840 (Multi-State Partnership), Schedule E from your federal return, and documentation from the local housing authority about the property’s compliance status.

One thing most people miss: the FTB isn’t just checking whether you paid rent — they’re checking whether the property was legally habitable when you collected it. If a city or county inspector cited the property under California Civil Code Section 1941, rental income from that period may be disallowed entirely, even if tenants continued paying. State law allows the FTB to disallow up to 100% of net rental income tied to a substandard unit.

We pull together the compliance timeline, coordinate with your local building department for official clearance letters, and draft a cover letter that frames the documentation correctly. Getting the narrative right matters as much as the documents themselves.

Yes — California Revenue and Taxation Code Section 17299.6 explicitly allows the FTB to disallow deductions for expenses related to substandard residential rental property. This means depreciation, mortgage interest, repairs, and management fees can all be denied for the period the property was cited as substandard. The disallowance applies even if the violations were minor or later corrected.

The statute has a safe harbor: if you can show you were actively working to correct the violations and the local agency certified compliance within a reasonable time, the FTB may allow deductions for that correction period. The key phrase is ‘actively working’ — you need written correspondence with the building department, contractor invoices, and inspection appointment records. An oral agreement with a tenant inspector won’t cut it.

We help clients document the remediation timeline and argue for the safe harbor when it applies. In cases where violations predate a client’s ownership, we’ve successfully argued full deductibility by showing the prior owner was responsible for the citation.

Ignoring the AUD 1573 is a fast path to a proposed assessment. The FTB will issue a Notice of Proposed Assessment (NPA) based on the information they already have, which almost always means disallowing all rental income adjustments and adding a 20% accuracy-related penalty on top of the additional tax. Interest accrues daily at the applicable federal rate plus 3%.

California has a 4-year statute of limitations for standard audits, but if the FTB believes there’s fraud or a substantial understatement (more than 25% of gross income), they can go back 8 years. A non-response to AUD 1573 can be treated as evidence of non-cooperation, which lowers the bar for the FTB to apply the fraud exception and look at older returns.

We’ve handled cases where clients came to us after ignoring two or three FTB notices. The accounts receivable balance by that point — with penalties and interest — was often double the original tax. Responding on time is almost always cheaper than dealing with the escalation.

Not directly — the FTB audit is a state-level process and doesn’t automatically trigger an IRS audit. But if the FTB disallows deductions on your California return and you made the same claims on your federal Schedule E, you likely have an inconsistency between your state and federal returns. The IRS has a separate data-sharing agreement with California under IRC Section 6103(d), and material discrepancies do get flagged.

If the FTB assessment results in a change to your California taxable income, you’re supposed to file an amended federal return within 120 days to report the adjustment — this is required under IRC Section 1311 if the state change affects federal basis. Most taxpayers don’t know this and skip the federal amendment, which creates a second exposure point.

We coordinate the California and federal filings when a state audit results in an adjustment. Amending the federal return proactively, rather than waiting for an IRS notice, puts you in a much stronger position and often reduces the overall penalty exposure.