I've told a potential landlord (via email) that I will meet with them on a particular day/time to sign a CA lease, pay deposit, get keys, etc. Since then, I've found another, better place to rent and don't want to proceed with landlord #1. I have paid a $500 holding deposit to landlord #1 and they stopped advertising the rental a couple of weeks ago when I paid the deposit.

What liability might I have if I don't sign the lease with landlord #1?

They could say they are keeping the money because they lost advertising time and possible potential renters. You can back out since you didn't sign anything but you do run the risk of losing the $500.

I agree. Kiss your $500 good bye and rent the nicer place.