Are sales of mortgage notes included in California's sales factor at gross proceeds or net gain?
Edvin Givargis Published 7 minute read
The short answer
It depends on what the seller is. A general corporation includes gross receipts in the sales factor at the gross amounts realized, not reduced by the basis of the property sold, subject to the specific statutory exclusions in Revenue and Taxation Code Section 25120(f)(2). A bank or financial corporation is different: under the special industry rules of Regulation 25137-4.2, receipts from the sale of loans, including mortgage loans, enter the receipts factor only at net gain, and never below zero. So a company that regularly sells mortgage notes must first answer a classification question, whether it is a financial corporation under the moneyed capital predominance test, before it can compute its factor, and the classification also decides whether it pays California franchise tax at 8.84 percent or 10.84 percent.
Two tax regimes, one classification test
California imposes its general franchise tax on corporations at 8.84 percent of net income. Banks and financial corporations are carved out of the general regime (RTC 23182) and taxed instead at a higher rate, currently 10.84 percent (RTC 23186). The additional two percentage points are an in-lieu rate: banks and financial corporations are exempted from certain local levies, principally personal property taxes and business license taxes, and the add-on compensates for that exemption. Alongside the rate difference, financial corporations are subject to special apportionment rules built for their industry (Cal. Code Regs. tit. 18, § 25137-4.2), which differ from the general rules in both what the receipts factor includes and where receipts are assigned.
Whether an entity is a financial corporation is a regulatory definition, not an election. Under Regulation 23183, a financial corporation is one that predominantly deals in money or moneyed capital in substantial competition with the business of national banks. Predominantly means more than 50 percent of total gross income is attributable to those dealings. Classification does not whipsaw year to year: an established classification changes only when the corporation fails the 50 percent test for two consecutive years and also fails it on a three year average of the current and two preceding years.
Dealing in moneyed capital
The operative phrase is dealing in money or moneyed capital, and the regulation gives it a specific meaning: conducting transactions on the corporation's own account, as opposed to brokering the capital of others. Moneyed capital includes coin, cash, currency, mortgages, deeds of trust, conditional sales contracts, loans, commercial paper, installment notes, credit cards, and accounts receivable. A company that originates mortgage loans with its own funds, holds mortgage notes for its own account, and sells them is dealing in moneyed capital in the most literal sense. By contrast, a firm whose income is predominantly fees for arranging or servicing the capital transactions of others is not: the regulation's own example is a stock brokerage that earns most of its income buying and selling securities for customers, which is not a financial corporation however financial its business looks.
The second element, substantial competition with national banks, requires that the corporation and national banks seek and secure capital investments of the same class in the same locality. Competition need not span every phase of banking. Mortgage lending is squarely a national bank activity, so an entity dealing in mortgage loans for its own account will ordinarily satisfy this element; the harder cases involve narrower asset classes or captive arrangements.
The classification analysis has to be run entity by entity, and it has to account for the entity's tax character. A limited liability company classified as a partnership is not itself the taxpayer, and the classification and rate questions travel to its corporate members, with combined reporting rules that address the mixing of financial and general members in one group (Cal. Code Regs. tit. 18, § 25137-10). The same portfolio of mortgage activity can therefore produce different answers depending on where in the structure it sits.
The general rule: gross amounts realized
For a corporation that is not a financial corporation, the sales factor rests on the statutory definition of gross receipts. For taxable years beginning on or after January 1, 2011, Section 25120(f)(2) defines gross receipts as the gross amounts realized on the sale or exchange of property, expressly not reduced by the cost of goods sold or the basis of the property sold. On its face, that puts the full selling price of a mortgage note in the factor, not merely the gain.
The exclusions matter, though, and two of them sit close to this fact pattern. Amounts received from the repayment, maturity, or redemption of the principal of a loan are excluded, so a company collecting principal on notes it holds does not run that principal through the factor; the exclusion addresses repayment, which is distinct from a sale of the note to a third party. And amounts received from the maturity, redemption, sale, or exchange of intangible assets held in connection with a treasury function are excluded entirely. A corporation whose loan portfolio is an investment of working capital rather than the product of a lending business can find its note sales excluded from the factor altogether under the treasury function rule. The gross inclusion answer therefore belongs to a taxpayer whose dealing in notes is itself the business that produces business income, and the factor treatment should be consistent with the business income characterization of the gains.
The financial corporation rule: net gains only
For a bank or financial corporation, Regulation 25137-4.2 displaces the general computation. The regulation builds the receipts factor item by item, and for loan sales the rule is explicit: the factor includes net gains, but not less than zero, from the sale of loans, stated separately for loans secured by real property and loans not secured by real property. Gross proceeds never enter the factor. The same net treatment applies to gains from securities dealings, reflecting the industry reality that a financial business turns over principal amounts that dwarf its economic income, and a gross factor would distort the apportionment the factor exists to measure.
The regulation also supplies its own geography. Interest from loans secured by real property is assigned to California when the secured property is located here, and the net gains from selling such loans follow the same path: the California portion is computed by a fraction keyed to the interest on those loans that the regulation assigns to the state. Gains on the sale of a mortgage portfolio thus land where the mortgaged properties are, not where the buyer or the trading desk sits.
These receipts rules survived California's recent overhaul of financial industry apportionment. Under legislation enacted in 2023, banks and financial corporations, which had long apportioned with an equally weighted three factor formula, move to the same mandatory single sales factor as general corporations for taxable years beginning on or after January 1, 2025. The change eliminates the property and payroll factors but leaves the receipts factor computation, including the net gain rules and the special sourcing of Regulation 25137-4.2, in place. The classification question consequently matters more after the change, not less: with apportionment resting entirely on receipts, the difference between a factor built on gross proceeds and one built on net gains can swing the California percentage dramatically for any company that turns over its note portfolio.
Practice notes
The order of operations is the point. First, classify before computing: run the Regulation 23183 predominance test on actual gross income composition, on the corporation's own account versus for others, before assuming either factor treatment, and rerun it when the business mix shifts, remembering the two year and three year average rules that stabilize an existing classification. Second, respect the coupling between classification and rate: the net gain factor treatment and the 10.84 percent rate arrive together, and a taxpayer cannot take the financial corporation apportionment rules while paying the general rate, so the modeling should compare complete packages rather than mixing favorable pieces. Third, for a general corporation selling notes, test the exclusions before defaulting to gross inclusion: principal repayments are out, treasury function receipts are out, and what remains in the factor should match what the income side treats as business income. Fourth, document the sourcing file for real property loans: the location of the secured properties drives both interest sourcing and gain sourcing under the special rules, and a portfolio level schedule of property locations is the workpaper that supports the factor in examination.
This article states the law as of September 14, 2026
Statutes, rates, thresholds, and agency practice change, and a different set of facts can change the answer. Before acting on anything discussed above, contact G&G State Tax Group to confirm what has changed since this was written and how the rules apply to a specific situation.
G&G State Tax Group, LLC is a state and local tax advisory firm. The firm provides state and local tax consulting and representation in state and local tax controversies. G&G does not prepare or file tax returns, perform attest services, or provide bookkeeping, and is not a CPA firm.