When taxpayers sell property used in a trade or business or certain involuntary conversions (IRC section 1231 property), losses are netted against gains. If section 1231 losses exceed section 1231 gains, the losses receive ordinary tax treatment. If section 1231 gains exceed section 1231 losses, the gains receive capital gain tax treatment. Section 1231 gains and losses retain this characterization regardless of whether the taxpayer changes their residency status.  For purposes of computing California taxable income, net only California source section 1231 gains and losses.

Example - Sale of Trade or Business - The taxpayer is a resident of Washington.  His California and non-California source section 1231 gains and losses for the year included a $3,000 California gain, a $2,000 California loss, a $4,000 Washington gain and a $5,000 Washington loss.  Based upon the netting of the taypayer's total and California source section 1231 gains and losses, determine his capital gain or ordinary loss as follows: