In a recent article, tax implications for covered call writing was discussed. In this publication I will highlight the tax ramifications as they apply to selling put options.
What is a Capital Gain?
A capital gain is an increase in the value of as capital asset, such as a stock or an option that gives it a higher worth than the purchase price. Capital gains must be claimed on income taxes in non-sheltered accounts.
Rules for Cash-Secured Put Writers
Premiums received for writing a put are not included as income at the time of receipt, but are held in suspense until the writer’s obligation to purchase the underlying stock expires, until the put is exercised and the writer purchases the stock, or by closing the option position (buy-to-close). With that in mind, here are three possible scenarios that may occur after the sale of the option:
1- An expired option (we sold the put, we didn’t close the position by buying back the option, and the holder did not exercise the option) results in a short-term capital gain. For example, we sell a BCI April $90 put for $4.50 in March. The proceeds are $450. Since the cost is $0, the short-term capital gain is $450. The acquisition date will be LATER than the sales date and the word “Expired” should be written in column e, the cost basis column of Form 8949.
2- If we buy back the same option in the above example to close the position (usually to initiate an exit strategy), the difference between the sale profit and the buyback cost will represent a capital gain or a capital loss. As in example 1, above, the acquisition date will be LATER than the sales date.
Capital gain example: We close our position by buying back the option for $250. The capital gain is $200 ($450 – $250).
Capital loss example: We close our position by buying back the option for $550. The capital loss is $100 ($550 – $450).
3- If the option is exercised, the option transaction becomes part of the stock transaction. The option premium is subtracted from the price you paid for the stock, reducing your basis. Example: You sold the BCI April $90 put for $4.50. The put is exercised and you pay $90 per share for the stock. Normally, your cost basis would be $90. However, you received $4.50 per share for the put premium. This reduces your cost basis in the acquired shares to $85.50 ($90-$4.50). There is no gain or loss to report on the option trade. When you sell the BCI shares you will simply enter $85.50 in the cost basis column. The holding period of the shares from the exercise date until the sale date will determine if the transaction is long or short term. The holding period of the option is ignored.
***The Schedule D of the Elite Calculator is designed to assist your tax advisor with these long and short-term capital gains (losses) issues.
The specific information referenced above can be found in IRS Publication 550 entitled Investment Income and Expenses, pages 59 – 61.
Personally, I choose to avoid these tax issues by trading options predominantly in tax-sheltered accounts.
Central Florida seminars
It was a real treat for me to meet so many of our BCI members during my three presentations in central Florida this past week:
Next live seminar: Charlotte, North Carolina:
The market reacted favorably when Federal Reserve Chairwoman, Janet Yellen, stated that an interest rate hike by the April meeting was unlikely although it could happen any time after that. This week’s economic reports:
- The Fed removed the word “patient” from the central bank’s description of its approach to raising interest rates. This was expected
- The Fed also lowered its estimated increases in short-term interest rates due to concerns in the labor market
- Unfavorable weather conditions caused new residential construction to decline by 17% in February, below expectations
- Year-over-year, housing starts declined by 3.3%
- Housing permits rose by 3% in February and are up 7.7% from February, 2014. This bodes well for construction activity over the next six months
- Industrial production increased by 0.1% in February, slightly below expectations
The Conference Board’s index of leading indicators (a window into economic outlook over the next 3 – 6 months) rose by 0.2% in February
IBD: Uptrend resumes
GMI: 6/6- Buy signal since market close of January 23, 2015
BCI: Cautiously bullish using an equal number of in-the-money and out-of-the-money strikes. I am linclined to be more conservative until we can view the market reaction to the first interest rate increase.
Wishing you the best in investing,