Options trading may not be as risky or complex as many stock investments, but they’re still subjected to tax laws like any other stock strategies. It’s important to have an understanding of the basics of how the IRS treats options before you try any option strategies. We’re giving you an introduction to some common tax rules for options. You will need to talk to a tax professional to make sure you’re following the correct and most updated laws for your situation.
Keep in mind, these rules apply to taxable accounts (Individual, Joint, Trusts, etc.). Tax-deferred (retirement) accounts won’t have these same rules. In these accounts, investors aren’t taxed on the gains annually.
What are the tax implications?
Generally, the reporting of gains and losses from call and put options is a lot easier than in the past. Most brokers supply account holders with a detailed breakdown of all their transactions for the year. Many also include a way to generate a Form 8949, the official tax form required by the IRS. Below, we have listed some specific tax reporting rules for both puts and calls to be aware of.
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Tax treatment of puts
- If the put holder (buyer) sells the option: The holder will need to report the difference between the cost of the put and amount received, as a capital gain or loss. This does not affect the seller in any way.
- If put option expires instead of being exercised: The holder will need to report the cost of the put as a capital loss on the date of expiration. The seller reports the amount they received for selling the put as a short-term capital gain.
- If a put option is exercised: The holder will need to subtract the amount realized from the sale of the stock by the cost of the put. The seller will need to reduce their basis of the stock they purchase by the amount received for selling the put option.
Tax treatment of calls
- If the call holder (buyer) sells the option: The holder will need to report the difference between the cost of the call and amount received, as a capital gain or loss. This does not affect the seller in any way.
- If call option expires instead of being exercised: The holder will need to report the cost of the put as a capital loss on the date of expiration. The seller reports the amount they received for selling the call as a short-term capital gain.
- If a call option is exercised: The holder will need to add the cost of the call option to your basis in the stock purchased. The seller will need to add the premium received to the proceeds for selling their shares to calculate the total gain or loss on the shares.
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What are the pros and cons?
Understanding tax treatments of put and call options is important to knowing how to make the most out of your option investing. However, there are many more special IRS rules for put and call options than what we can’t discuss here. It’s important to talk to a tax professional for the right way to report them on your tax return. That way you’re sure to comply with the most updated rules for your situation.
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