Options

<div class="Section1">When a put or call (whether listed or unlisted) expires without exercise (i.e., lapses), the premium that has been carried by the writer in a deferred account since the option was sold (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7574">7574</a>) is recognized as short-term capital gain and included in the writer&rsquo;s gross income for the tax year in which the option expired.<a href="#_ftn1" name="_ftnref1">¹</a> <em><em>See</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="702">702</a> for the treatment of capital gains and losses.<div class="Section1"><br /> <br /> Under regulations expected to be issued in the future, if the underlying property on which the option is written becomes worthless, the taxpayer will recognize gain or loss in the same manner as if the contract were closed when the property became substantially worthless.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; IRC &sect;&nbsp;1234(b)(1); Rev. Rul. 78-182, 1978-1 CB 265.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp; IRC &sect;&nbsp;1233(h)(1).<br /> <br /> </div></div><br />

<div class="Section1">The writer of a put (listed or unlisted) realizes no taxable gain or loss on the purchase of the underlying stock pursuant to exercise of the put. However, for purposes of determining the writer’s gain or loss on a subsequent sale of the underlying stock, the writer’s tax basis in that stock is reduced by the amount of the option “premium” received in the original sale of the put. Furthermore, the holding period of the underlying stock begins on the date of its purchase, not on the date the put was written.<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.   Rev. Rul. 78-182, 1978-1 CB 265.<br /> <br /> </div>

<div class="Section1"><br /> <br /> A &ldquo;wash sale&rdquo; (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7536">7536</a>) is a sale or other disposition of <em>stock or securities</em> in which the seller, within a 61-day period (beginning 30 days before and ending 30 days after the date of such sale or disposition), replaces those shares of stock or securities by acquiring (by way of a purchase or an exchange on which the full gain or loss is recognized for tax purposes), or entering into a contract or option to acquire, substantially identical <em>stock or securities</em>.<a href="#_ftn1" name="_ftnref1">¹</a> For the tax effect of a wash sale involving a sale of stock at a loss followed by a purchase of an option, <em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7536">7536</a>.<br /> <br /> Options to acquire or sell stock or securities are generally included in the definition of stock or securities for purposes of the wash sale rule (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7539">7539</a>); consequently, the sale (at a loss) and reacquisition of options, with or without ownership of the underlying stock, would trigger the wash sale rule. Similarly, it would appear that &ldquo;substantially identical stock or securities&rdquo; would include &ldquo;substantially identical options or contracts to acquire or sell stock or securities&rdquo; as well.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; IRC &sect;&nbsp;1091(a);&nbsp;Treas. Reg. &sect;&nbsp;1.1091-1(a).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp; IRC &sect;&nbsp;1091(a).<br /> <br /> </div></div><br />

<div class="Section1">A <em>cash settlement option</em> is an option that on exercise settles in, or could be settled in, cash or property other than the underlying property.<a href="#_ftn1" name="_ftnref1">¹</a> For example, an option on a stock index that contemplates that cash, rather than stock, be transferred if the option holder elects to exercise the option is a cash settlement option.</div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.   IRC § 1234(c)(2)(B).<br /> <br /> </div>

<div class="Section1">In the case of options on individual stocks, a &ldquo;call&rdquo; option (or simply, a &ldquo;call&rdquo;) is an option contract giving the owner thereof the right to <em>purchase</em> from the writer of the call, at any time before a specified future date and time, a stated number of shares of a particular stock at a specified price.<a href="#_ftn1" name="_ftnref1">¹</a> <em><em>See</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7562">7562</a> through Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7585">7585</a> for the tax treatment of various transactions involving the purchase, holding, and disposition of puts, calls, nonequity options, and combinations thereof.<div class="Section1"><br /> <br /> A &ldquo;put,&rdquo; on the other hand, is an option contract giving the owner thereof the right to <em>sell</em> to the writer of the put (i.e., to &ldquo;put it to him or her&rdquo;), at any time before a specified future date and time, a stated number of shares of a particular stock at a specified price.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> In any case, only the grantor of an option is obligated to perform on it; the purchaser or subsequent owner of a &ldquo;call&rdquo; or &ldquo;put&rdquo; may choose to dispose of it or allow it to expire.&nbsp;The owner of an option (whether it is a put or a call) is referred to as holding a &ldquo;long&rdquo; position; the writer (i.e., grantor or seller) of an option is referred to as holding a &ldquo;short&rdquo; position.&nbsp;Thus, it is always the holder of the short position who is obligated to perform on the contract and the holder of the long position who may choose to exercise the contract or permit it to lapse.<br /> <br /> The price a purchaser pays to the writer of an option as consideration for the writer&rsquo;s obligation under the option is referred to as the &ldquo;premium&rdquo; or &ldquo;option premium.&rdquo;<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; Rev. Rul. 78-182, 1978-1 CB 265; Rev. Rul. 58-234, 1958-1 CB 279.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp; Rev. Ruls. 78-182, 58-234, 1978-1 CB 265.<br /> <br /> </div></div><br />

<div class="Section1">The owner of a call (whether listed or unlisted) will realize no taxable gain or loss on the exercise of the call option and the purchase of the underlying stock. However, for purposes of determining gain or loss in a subsequent sale or exchange of that stock, the option premium paid by the owner to acquire the call is added to the tax basis in the stock.<a href="#_ftn1" name="_ftnref1">¹</a><div class="Section1"><br /> <br /> Certain combinations of options, or options held contemporaneously with offsetting positions that have the effect of reducing both the taxpayer&rsquo;s risk of loss and opportunity for gain, may trigger constructive sales treatment under IRC Section&nbsp;1259 (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7617">7617</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7621">7621</a>).<br /> <br /> The contemporaneous holding of a call option and granting of a put option with respect to an equity interest in a pass-through entity may constitute a &ldquo;constructive ownership transaction&rdquo; under IRC Section&nbsp;1260 (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7622">7622</a> and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7623">7623</a>).<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; Rev. Rul. 78-182, 1978-1 CB 265.<br /> <br /> </div></div><br />

<div class="Section1">No. Commissions paid by a writer to sell a put or call (whether listed or unlisted) merely reduce the total “option premium” received in consideration for the obligations under the option.<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.   Rev. Rul. 58-234, 1958-1 CB 279; Rev. Rul. 68-151, 1968-1 CB 363.<br /> <br /> </div>

<div class="Section1">If the writer of an unlisted option repurchases the option from its holder, he or she will realize <em>short-term</em> capital gain or loss to the extent of the difference between the premium paid to repurchase the option and the premium originally received by the writer.<a href="#_ftn1" name="_ftnref1">¹</a><em><em> See</em> </em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="702">702</a> for the treatment of capital gains and losses.<div class="Section1"><br /> <br /> Certain combinations of options, or options held contemporaneously with offsetting positions that have the effect of reducing both the taxpayer&rsquo;s risk of loss and his or her opportunity for gain, may trigger constructive sales treatment under IRC Section&nbsp;1259.&nbsp;The operation of these rules is explained at Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7617">7617</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7621">7621</a>, and the effect of closing out or reopening certain transactions that are subject to constructive sale treatment is explained at Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7618">7618</a>.<br /> <br /> The contemporaneous holding of a call option and granting of a put option with respect to an equity interest in a pass-through entity may constitute a &ldquo;constructive ownership transaction&rdquo; under IRC Section&nbsp;1260 (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7622">7622</a> and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7623">7623</a>).<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; IRC &sect;&nbsp;1234(b); Rev. Rul. 78-181, 1978-1 CB 261.<br /> <br /> </div></div><br />

<div class="Section1">For taxable years beginning after 2001, the term &ldquo;equity option&rdquo; includes an option on a group of stocks <em>only if</em> that group meets the requirements for a <em>narrow-based security index </em>(as defined in Section&nbsp;3(a)(55)(A) of the Securities Exchange Act of 1934) (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7560">7560</a>).<a href="#_ftn1" name="_ftnref1">¹</a> For taxable years beginning before 2000, options <em>other than stock options</em> could be classified as &ldquo;equity&rdquo; options for federal income tax purposes if their value was determined by reference to a <em>group</em> of stocks or stock index, but they were of a type that was ineligible to be traded on a commodity futures exchange. (An example of such an option would have been an option contract on a sub-index based on the price of nine hotel-casino stocks.) An equity option could be either a <em>listed option</em> or an <em>unlisted option</em> (i.e., traded over-the-counter or otherwise).<a href="#_ftn2" name="_ftnref2">²</a><div class="Section1"><br /> <br /> These &ldquo;other&rdquo; equity options were generally taxed under the same rules that apply to stock options.<em><em> See</em> </em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7556">7556</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7580">7580</a> for details. For the application of the straddle rules to such options,<em><em> see</em> </em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7593">7593</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7614">7614</a>.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; IRC &sect;&nbsp;1256(g)(6).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp; IRC &sect;&nbsp;1256(g)(6), prior to amendment by CRTRA 2000.<br /> <br /> </div></div><br />

<div class="Section1">Nonequity options are taxed under the mark-to-market rules that apply to regulated futures contracts and other IRC Section&nbsp;1256 contracts (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7592">7592</a>).<div class="Section1"><br /> <br /> Like any other position taxed under the &ldquo;mark to market&rdquo; requirements, a nonequity option is excluded from the definition of an <em>appreciated financial position</em> under IRC Section 1259(b)(2)(B) (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7617">7617</a>). However, it appears that, depending on the taxpayer&rsquo;s other holdings, the acquisition of a nonequity option could be construed as a constructive sale of a position that is substantially identical to the nonequity option or the property underlying it.<a href="#_ftn1" name="_ftnref1">¹</a> Future regulations may clarify this and other issues with respect to the application of IRC Section&nbsp;1259 to options transactions.<br /> <br /> For the tax treatment of a nonequity option that is part of a tax straddle,<em><em> see</em> </em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7593">7593</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7614">7614</a>. For the tax treatment of a nonequity option that is considered part of a conversion transaction,<em><em> see</em> </em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7615">7615</a> and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7616">7616</a>.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; IRC &sect;&nbsp;1259(c)(1)(E).<br /> <br /> </div></div><br />