Saturday, September 21, 2019
Helping Family Businesses succeed.
placeholder
Have a Question? We can help. click to Ask an Expert.

Strategies for Tax Planning: Options, Puts and Calls

While investing in options, puts and calls may not be for everyone, there are ways to utilize these transactions strategically to reduce your federal tax burden. Options give an investor (“the holder”) the right to purchase (“call”) or sell (“put”) a security at a predetermined strike price by a predetermined expiration date from a seller (“the writer”).  The buyer has the option to buy or sell under the agreement, along with the right to let the option lapse (sometimes subject to a loss of a premium paid for the option) – or the right to trade the option to another investor on the open market.

How this affects tax liabilities is through capital gains or losses. When a holder uses an option, any gain or loss is based on the length of time the underlying securities is held, not on the length of time the option was held. This can affect whether gains or losses are considered short-term (up to one year) or long-term (over one year). The taxable event comes at the end of the option period, when an investor exercised the option, lets the option lapse or trades it on the open market.

Now more about that:

  • Exercising a Call Option – When you exercise a call option, you are opting to buy the underlying securities. The purchase price for the option, along with any commissions and fees, is added to the tax basis for the securities. When you sell the underlying securities, you will realize a capital gain or loss, calculated against your cost basis.
  • Exercising a Put Option – When you exercise a put option to sell the underlying securities, your capital gains is reduced by the premium, commissions and fees you paid for the option. Whether your gain or loss will be long-term or short-term is based on the time from when you purchased the underlying securities to the time when you purchased the put.
  • Letting the Option Lapse – In most cases if you do not exercise your option, the transaction is recorded at $0, and you will have a loss in the amount of the premium, fees and commissions. Whether the loss is considered short-term or long-term depends on how long you held the option but can be dependent on how long you held the securities before purchasing the option. (Consult your tax advisor.)
  • Trading the Option – Trading your option on the open market or back to the writer before the expiration date results in a gain or loss, which will be determined short-term or long-term depending on the holding period of the option.

Here is a snapshot on tax implications of options transactions:

Transaction

Short-term vs. Long-term

Capital Gains

Exercise a Call Option

Determined when you sell the underlying securities. Holding period begins when you exercise your option.

The difference between the sale price of the underlying securities and their tax basis, which is the price paid for the option plus underlying securities’ tax basis, fees and commissions.

Exercising a Put Option with securities held long-term at time of put purchase

Any gain or loss is considered long term. Holding period begins when you purchased the underlying securities and ends when you purchased the put.

Reduced by commissions, fees and the premium you paid for the option.

Exercising a “Married” Put – when securities and put are purchased same day

Determined by the time you held the option.

Reduced by commissions, fees and the premium you paid for the option.

Exercising Put Option with securities held short-term at time of put purchase

Treated as a short sale, regardless of when you purchased the securities. Holding period now starts on the date you exercise the option.

Reduced by commissions, fees and the premium you paid for the option.

Letting the Option Lapse

Determined by how long you held the option but can be dependent on how long you held the securities before purchasing the option. (Consult your tax advisor.)

The transaction is recorded at 0$, and you will have a loss based on commissions, fees and the premium you paid for the option.

Trading the Option – selling an acquired call option

Determined by the holding period of the option.

Reduced by commissions, fees and the premium you paid for the option.

Trading the Option – selling a put option for securities held long-term

Determined as long-term based on the holding period of the underlying securities.

Reduced by commissions, fees and the premium you paid for the option.

Trading the Option – selling a put option for securities held short-term

Determined as short-term based on the holding period of the underlying securities, regardless of how long you held the option. The holding period now begins the date the put was purchased.

Reduced by commissions, fees and the premium you paid for the option.

Trading the Option – selling a “married” put

The holding period start date remains the date you purchased the securities and the put. The marriage is dissolved at time of the trade and you keep the underlying securities.

Reduced by commissions, fees and the premium you paid for the option.

Additional rules apply for other transaction scenarios and for option writers. The above pertains only to equity options and federal income tax, not to state and foreign taxes. Consult a tax planning professional before including options in your portfolio, and refer to IRS Publication 550, Investment Income and Expenses.

IRS CIRCULAR 230 DISCLOSURE: To ensure compliance with requirements imposed by the U.S. Internal Revenue Service, we inform you that any tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, by any taxpayer for the purpose of (1) avoiding tax-related penalties under the U.S. Internal Revenue Code or (2) promoting, marketing or recommending to another party any tax-related matters addressed herein.

Contributing Sources:   http://www.forbes.com/2006/08/23/investools-options-ge-in_wh_0823investools_inl.html; http://www.smartmoney.com/taxes/income/taxes-on-options-151-puts-and-calls-9537/

| Terms Of Use | Privacy Statement
Copyright 2019. Broadway Bank. Content is not a substitute for legal and tax advice