Income Tax on Puts and Calls

When you deal in put and call options, the federal income tax depends on what you do with the options, such as sell the options themselves, use the options to buy or sell stock, or let the options expire. Options are not included in the 1099 statement you receive from the brokerage firm so you will need to refer to your account statement for the information you need to report your activity in options on your federal income tax return.

A call is the right to buy a certain number of shares of stock at a certain price before the expiration date. A put is the right to sell stock at a certain price before the expiration date. The federal income tax on options transactions depends on whether you are the writer or the holder of the put or call option.

If you buy a put or call option you are the holder. If you sell the option itself, the difference between your cost and the amount realized on the sale would be a capital gain or loss, either short term or long term, depending on how long you held the option. You would report this on Schedule D, Capital Gains and Losses.

If you are the holder and you let an option expire, you would have a loss. The sales proceeds would be zero and the cost would be what you paid for the option. On Schedule D you would enter the expiration date in column (c) and enter "Expired" in column (d) for the sales price.

If you exercise a call option to purchase stock, the amount you paid for the option is added to the basis of the stock. So your basis in the stock would be the exercise price plus the cost of the call option. When you eventually sell the stock, you would have a capital gain or loss determined as the proceeds from the sale minus your basis in the stock.

If you exercise a put option to sell stock, you would reduce the amount realized on the sale by the cost of the put. Your gain or loss on the sale of the underlying stock would be long term or short term, depending on your holding period.

According to the IRS, when you buy a put option, the transaction is generally treated as a short sale for tax purposes. The sale, exercise, or expiration of the put option is considered a closing of the short sale. If you have held the underlying stock for one year or less when the put option is exercised, sold, or allowed to expire, any gain would be a short-term capital gain. This is also the case if you buy the underlying stock after you buy the put option but before the option is exercised, sold, or expires.

For a put option, your holding period for the underlying stock starts on the date you sell the stock, the date you exercise the put, the date you sell the put, or the date the put expires, whichever is earliest.

Sources:

Instructions for Schedule D, Capital Gains and Losses, IRS

Publication 550, Investment Income and Expenses, IRS