California's FTB 3526 limit compares investment interest with itself instead of with investment income #10218

Title: California's FTB 3526 limit compares investment interest with itself instead of with investment income

Problem

ca_investment_interest_expense_deduction computes FTB 3526 line 6 (net investment income) as investment_interest_expense − investment_expenses, not as investment income less investment expenses. Line 8 is the smaller of line 3 and line 6, so the result is never limited by investment income. The deduction becomes the full interest expense, less investment expenses:

net_investment_income = max_(0, investment_interest_expense - investment_expenses)
return min_(investment_interest_expense, net_investment_income)

The existing test ca_itemized_deductions_pre_limitation.yaml Case 2 encodes this. It has $10,000 of investment interest, $2,000 of investment expenses and no investment income, and expects $8,000. FTB 3526 gives $0, with $10,000 carried forward.

#9977 replaces the federal Schedule A line 9 with the Form 4952 limit but keeps this California formula, so the gap survives that PR.

Reproduction (main, 2.42.0)

Synthetic case: 2025, single, CA. $300,000 wages, $1,000 taxable interest, $20,000 investment interest expense (as from Schedule K-1 box 13 code H), nothing else.

Fix

Use California investment income on line 4f:

• Line 4a: gross income from property held for investment: interest, all dividends (California has no qualified dividend rate, so there is no line 4g election), annuities and royalties.
• Line 4d: net gain from investment property, excluding net capital gain.
• Line 4e: the elected net capital gain.

Then line 6 = 4f − line 5, and line 8 = min(line 3, line 6). Once #9977 lands, its form_4952_* inputs (prior-year disallowed interest, the election) could feed the California lines. I can open a PR either way: now, with line 4a and an elected-gain input, or stacked on #9977.

Sources

• 2025 FTB 3526, lines 1–8. Line 4a instructions (PDF p. 2): "gross income from property held for investment … from interest, dividends, annuities, and royalties."
• 2025 Schedule CA (540) instructions, Part II line 9: "Use form FTB 3526 … to figure the amount to enter on line 9."
• 26 U.S.C. 163(d)(1), (d)(4), which California follows (FTB 3526 instructions: "Generally, California law for the investment interest expense deduction follows federal law").