And we will examine special rules that apply to some ETF and index options. This is an extremely difficult, if not impossible problem to overcome with any automated trade accounting and tax software program. You must realize the gain on the date of the constructive sale, and the transaction will be reported to the IRS.
Capital Gains and Losses
But if it was held longer, you have a long-term capital loss. Since all option contracts give the buyer the right to buy or sell a given stock at a set price the strike price , when an option is exercised, someone exercised their rights and you may be forced to buy the stock the stock is put to you at the PUT option strike price, or you may be forced to sell the stock the stock is called away from you at the CALL option strike price. There are special IRS rules for options that get exercised , whether you as the holder of the option you bought the option exercised your rights, or someone else as the holder of the option you sold the option exercised their rights.
Your option position therefore does NOT get reported on Schedule D Form , but its proceeds are included in the stock position from the assignment. When importing option exercise transactions from brokerages, there is no automated method to adjust the cost basis of the stock being assigned.
Brokers do not provide enough detail to identify which stock transactions should be adjusted and which option transactions should be deleted. See our User Guide for details. Put selling, or writing puts, is quite popular in a bull market. The advantage of this strategy is that you get to keep the premium received from selling the put if the market moves in two out of the three possible directions. If the market goes up, you keep the premium, and if it moves sideways, you keep the premium. Time decay which is inherent in all options is on your side.
Quite a nice strategy. Since the focus of our site is trader taxes, and not a commentary on various option trading strategies, we will concentrate our discussion on the potential problems that this particular strategy sometimes creates when attempting to prepare your taxes from trading.
If the market heads down one of the three possible directions , you may find yourself owning the stock as the option may get exercised and the stock gets put to you at the strike price. IRS Publication states that if you are the writer of a put option that gets exercised, you need to "Reduce your basis in the stock you buy by the amount you received for the put. This may sound simple, but as usual when it comes to taxes and the real world, nothing is quite that simple as the following example will show:.
Here is where the fun starts: But according to the IRS rules, when preparing his taxes, Joe needs to reduce the cost basis of the 1, shares by the amount he received from selling the put. But like I said, nothing in the real world is easy.
What happens if the ten contracts do not all get exercised at the same time? How does the premium received from the puts get divided up among the various stock assignments? The same goes for the three other purchases of , , and shares each with the remaining option premium divided accordingly. In addition, the option trade needs to be zeroed out because the amount received from the option sale has been accounted for when reducing the stock cost basis.
Now you would think all of this required accounting would be taken care of by your stock brokerage. Prior to tax year, most brokers simply report the individual option sale and stock purchase transactions and leave the rest to you. Some brokers attempt to identify the exercised options and the corresponding stock assignments, but leave much to be desired in the way they do so. This is an extremely difficult, if not impossible problem to overcome with any automated trade accounting and tax software program.
Few, if any, tax software programs designed for traders or investors handle this without much fuss and manual adjusting. Thankfully, TradeLog is able to make all such necessary adjustments with just a few clicks of your mouse!
Please see our Broad-Based Index Options user guide page for a complete list of index options marked by TradeLog as section contracts. TradeLog also allows users to define additional securities as broad-based index options in the Global Options settings. Since these do not settle in cash, as do most section contracts, some suggest that these are not section contracts. Others feel that they meet the definition of a "broad-based" index option and therefore can be treated as section contracts.
A recent article in Forbes magazine highlights just how complex the tax laws are when it come to Options and ETFs, and why you cannot rely on your broker B for proper tax treatment: As always, it is best to contact your tax professional for advice before arbitrarily categorizing your index options trades. Another is when you hold a stock and buy an option to sell at higher than the current market value -- buying that option represents a constructive sale. You must realize the gain on the date of the constructive sale, and the transaction will be reported to the IRS.
When you close the position, only report income net of the gain recognized on the constructive sale. If you sell options purchased before January 1, , the broker may not report the sale to the IRS. However, you are still required to report the transaction when you file your tax return.
Report each individual sale of options on Form , using the appropriate part for short- and long-term transactions. Transfer the totals to Schedule D to calculate your net capital gain or loss position for the tax year. Naomi Smith has been writing full-time since , following a career in finance. Her fiction has been published by Loose Id and Dreamspinner Press, among others. At the center of everything we do is a strong commitment to independent research and sharing its profitable discoveries with investors.
This dedication to giving investors a trading advantage led to the creation of our proven Zacks Rank stock-rating system. These returns cover a period from and were examined and attested by Baker Tilly, an independent accounting firm. Visit performance for information about the performance numbers displayed above. Skip to main content. Covered Securities The IRS began requiring brokers to keep track of cost basis for security trades beginning in with equity trades.
Capital Gains and Losses With the new reporting requirements, your broker statement and B will separate short- and long-term capital gains and losses.