# Taxation of Equity Options



## avrex (Nov 14, 2010)

I thought I would place this publication here as a *reference. *
(based on a discussion in another thread).
It discusses the taxation of equity Options. 

Tax Treatment of Gains and Losses on Options 
(written by KPMG for the TMX Group)

I like the examples that this publication provides.


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## lefilter (Mar 4, 2011)

Thanks.

However there is no mention of spreads. How would a put spread be treated?

- One event when the spread is closed
- Or multiple event? (premium as income at initiation, possible loss at close)


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## humble_pie (Jun 7, 2009)

lefiltre each individual leg in an all-option spread gets treated as an individual, independent trade. It doesn't matter whether there are 2, 3 or 4 legs, each one has a cost base & a proceeds-of-disposition amount to report.

if you look at the suggestions avrex & i made to argo about his jan/13 put spread, you will see that each side of this 2-legged spread is to be treated as a separate taxable gain or loss event.

however, exercise of options into underlying stock is a different ball park. Costs of such options are then amortized into cost bases of such stocks. This is the principal reason why i for one devoutly avoid all possible assignments.


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## lefilter (Mar 4, 2011)

"This is the principal reason why i for one devoutly avoid all possible assignments."

Absolutely!

I was confused as to why rolling a spread would postpone the capital loss for 2012. The way i see it, if you roll a loosing spread, you get a loss for 2012 and a smaller gain for 2012 also (the income generated by the new spread). So rolling would reduce your 2012 investment loss but it would not transfer it to 2013.


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## Argonaut (Dec 7, 2010)

lefilter said:


> The way i see it, if you roll a loosing spread, you get a loss for 2012 and a smaller gain for 2012 also (the income generated by the new spread).


I agree about the loss for 2012, but if the spread is rolled forward into 2013, I wouldn't think that the smaller gain would be applicable until the spread expires in the 2013 tax year. If I'm wrong about this, that would actually work out easier for my tax calculations this year.


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## humble_pie (Jun 7, 2009)

guys if i may say so, i think that the mistake you are both making is imagining that the tax authorities will "see" that you were doing a spread.

whereas all they are going to "see" is a series of individual trades. Buy, sell.

it's true that in a trader's mind, 2 trades may be intimately linked, were perhaps even contingent upon each other at the time of their execution. They might also have forward-looking contingencies in a roll strategy. But none of this matters to the tax man.

turning again to the jan 525/515P that will be closed in 2012:

- there are 2 closing transactions.

- trader sells the 515P for a profit. It's a capital gain because when he bought this option a while ago, he paid less. There is no way i know of to carry forward a gain, so if realized in 2012 it has to be reported in tax 2012.

- trader also buys back the 525P for a net loss. The price he must pay to buy back is greater than the proceeds he received when he sold the put in the first place. This is a capital loss, which he can either use immediately to offset his above-mentioned 2012 gain; or else he can carry this loss forward to the future, an action he is perhaps more likely to take if he's anticipating large gains in the future.

to really split a hair: if the above-mentioned loss on the 525P exceeds the 515P gain - and *IF* the trader has no other gains or losses for 2012 - then he can use part of the 525 loss to offset all of the 515 gain & he will still get to carry forward the unused portion of the loss.

notice that it takes a photonic fluorescence microscope to split hairs this fine.


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## Argonaut (Dec 7, 2010)

All of that sounds good. But question is, do gains made from the expiration of options occur in the year of expiry? This is what I assumed, and this is what seems to be the case from avrex's PDF.


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## humble_pie (Jun 7, 2009)

Argonaut said:


> All of that sounds good. But question is, do gains made from the expiration of options occur in the year of expiry? This is what I assumed, and this is what seems to be the case from avrex's PDF.


they occur in the year they are taken (ie by closing out a position) & *not* in the year of expiry as a definition. Of course, quite often these years are the same. In your case, they are probably not going to be the same.

tax authorities are said to be especially touchy about LEAPs options. People are trying to use these to push forward declaration of revenues for years & years.


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## Argonaut (Dec 7, 2010)

So if you write a covered call in November of 2012, and it expires in June of 2013, this counts towards your 2012 tax? Doesn't add up to me, because you have no idea what will happen with the position by next June. I'm not talking of closing a position, but expiration out of the money.


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## humble_pie (Jun 7, 2009)

Argonaut said:


> So if you write a covered call in November of 2012, and it expires in June of 2013, this counts towards your 2012 tax? Doesn't add up to me, because you have no idea what will happen with the position by next June. I'm not talking of closing a position, but expiration out of the money.


argo in replying to you i have been speaking only to your jan 515/525 put position, because you would be leaving the country for a while & it was a bit risky to leave these unattended. Avrex & i thought you should wind these up. I believe the implications of these 2 closing trades have been discussed ... elaborately.

cannot go on to theoretical discussion of what if what if what if. I am not willing to write a book. Taxation of options is a tricky matter. Accountants with experience (as opposed to those who "say" they have experience) are scarce as hen's teeth. They are also expensive. Still, perhaps it would be a good idea for you to set out to find one after you come back from holiday.

hint: i've said this many times before. Do not let options just expire. Close all positions so all trades will be recognized as capital gains/losses.


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## avrex (Nov 14, 2010)

Argonaut said:


> So if you write a covered call in November of 2012, and it expires in June of 2013, this counts towards your 2012 tax? Doesn't add up to me, because you have no idea what will happen with the position by next June. I'm not talking of closing a position, but expiration out of the money.


I should have actually read the document that I posted. I think I've misinterpreted/assumed something in the past that I shouldn't have.

Let's look at a short call scenario.
Let's assume that we have historically declared that we are trading on a capital account (i.e. capital gain/loss and not business income)

*Example 1*
Nov 1, 2012. I sell 1 GOOG 750 Jun 2013 call option for $31. This gets me a premium of $3100.
June 21, 2013. The underlying GOOG closes at $700 and the call option expires worthless.

Avrex's poor assumption: On my *2013 Taxes*, I declare a capital gain of $3100.

However, when I look on page 4 of, Tax Treatment of Gains and Losses on Options , it states,
_During the taxation year that the option is written, the writer is deemed by the Act to have disposed of a property whose adjusted cost base is nil, resulting in a capital gain equal to the amount by which the premium received exceeds any brokerage fees._
In the example on page 10, it states,
_Taxable capital gain in computing income for the year in which the option is written._

That would mean I would have to declare my capital gain of $3100, earlier than I thought, on my *2012 Taxes* (and not on my 2013 Taxes, as I had earlier assumed.)

*Example 2*
Nov 1, 2012. I sell 1 GOOG 750 Jun 2013 call option for $31. This gets me a premium of $3100.
April 1, 2013. I buy 1 GOOG 750 Jun 2013 call option for $11. I pay $1100 and close my position (prior to the expiration date).

How do I record this for tax purposes?
I have declared a $3100 capital gain on my *2012 Taxes*.
Do I now declare a $1100 capital loss on my *2013 Taxes*?


Dean (aka @TaxGuy), I was wondering if you have any comments on these examples.


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## Argonaut (Dec 7, 2010)

My plan was to do my taxes like this (capital gain upon writing) because I figured it was easier to keep track of. CRA would be welcome to adjust it themselves in the extremely rare case that it would ever come up. But like avrex, I assumed that expiration was when the tax event occurred, not upon writing the option. I guess we have managed to deduce something without hiring an expensive accountant.

In your Example 2, I would gather that you are correct in a 2012 gain and a 2013 loss, based on my interpretation of reading the document.

@humble: I can't imagine buying back all sold options, especially those 100% likely to expire worthless. For a spread that would be an unnecessary waste of $20+ for commissions. The exception is if one was with Interactive Brokers, and could close for a buck or two and get to the next trade sooner. I've let several AAPL and GOOG put sells expire worthless this year and plan to treat these as regular capital gains.

If I get a chance tomorrow I might do my rollover, although with AAPL at $540 I'm tempted to let it creep closer to expiry. I just hate to have a lot of margin tied up for a longer period when January is primetime for new investing. Not worth fretting about on the beach, I know, I know..


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## avrex (Nov 14, 2010)

avrex said:


> *Example 2*
> Nov 1, 2012. I sell 1 GOOG 750 Jun 2013 call option for $31. This gets me a premium of $3100.
> April 1, 2013. I buy 1 GOOG 750 Jun 2013 call option for $11. I pay $1100 and close my position (prior to the expiration date).
> 
> ...


Doing some internet research...
It looks like the website www.taxtips.ca agrees with my above tax declarations, in example 2, based on their interpretation of IT-479R Transactions in securities.


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## humble_pie (Jun 7, 2009)

Argonaut said:


> @humble: I can't imagine buying back all sold options, especially those 100% likely to expire worthless. For a spread that would be an unnecessary waste of $20+ for commissions. The exception is if one was with Interactive Brokers, and could close for a buck or two and get to the next trade sooner. I've let several AAPL and GOOG put sells expire worthless this year and plan to treat these as regular capital gains.


oh, absolutely, who can imagine the idiocy ! but, you see, if you don't buy back - & if you do a lot of options like me & eventually you might come to their attention - there is the risk that the tax authorities will want those short option sales to be taken into 100% taxable ordinary income. Because they are short sales.

yep. That's what i said. Income, not capital gains. Gah.

so to keep em happy that these are taxable gains & losses, i usually close all positions. It's also helpful to prevent assignments. I know i know all those extra commish not to speak of those nickels & dimes which the evil market makers insist on charging for their expiring last-minute bits of festering stinking offal are enough to make a poor piecrust weep. But think of this: for a dumb crumb, a tax trauma would be worse.

re your expired calls that you sold OTM ... yea treat em as capital transactions. You are not going to be audited for these trades, you don't have enough yet & you have not been at it long enough.

one of the many things that makes option tax reporting so tricky is that the securities acts themselves are vague & out-of-date. They were really written for when options were more avenues into buying a security, less independent derivatives trading in their own right.

so there are many interpretations. Other leading accounting firms may not agree with the KMPG document that avrex was kind enough to link. Most sinister of all, the tax authorities themselves may not agree. Even more shocking than this is the fact that the tax authorities may not even know what to do ...

imho what's important is to think carefully about each system that you adopt. If you can find that rarest of accountants to advise you, you will have found a gold mine. You don't want an accountant from a prestigious big firm; the senior partner will have one of his students write up a preposterous plan, taking every advantage of all the ambiguities & unexplained areas in the securities acts, while running the meter the whole time & then the firm will bill you $5000-10,000.

i might write more at a later date about how to find a really good accountant for options help, but it's late at night & the info is not necessary at this stage imho. Everybody here can still wing it themselves imho. Certainly avrex & argo have set out on the right path, by looking for methodologies that are accurate, fair, reasonable & consistent.


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## humble_pie (Jun 7, 2009)

thankx avrex for putting up a couple of concrete examples. It's always easiest to deal with specific examples. What are so impossibly difficult are theoretical, generalized questions.

taking up your 2 examples, i put the 2nd one first because it is simpler.



> Example 2
> 
> Nov 1, 2012. I sell 1 GOOG 750 Jun 2013 call option for $31. This gets me a premium of $3100.
> April 1, 2013. I buy 1 GOOG 750 Jun 2013 call option for $11. I pay $1100 and close my position (prior to the expiration date).
> ...


A: yes, you now have a 2012 capital gain of 3100 with a cost base of zero.

in 2013, if you would be buying back that short call for 11, you would have a loss of 1100. I'd report this as proceeds of zero with a cost base of 1100 to produce (1,100.00) in the gain/loss column.

however please note that other accountants could very well suggest doing it differently. There are many ways to skin an options tax cat.



> Example 1
> 
> Nov 1, 2012. I sell 1 GOOG 750 Jun 2013 call option for $31. This gets me a premium of $3100.
> 
> June 21, 2013. The underlying GOOG closes at $700 and the call option expires worthless.


the catchy part here is that option of yours which expires worthless. The risk is that the tax authorities will deem the original short sale to be a standard uncovered short sale which has to be taken into 100% taxable ordinary income.

oops. Then for me there is the risk that all the other sales will be treated in the same manner. Then all of a sudden ordinary income would be inflated by $100,000 or more (& lettuce remember that losses are not netted against ordinary income, only against gains.)

oops.

so i always move to forestall this nightmare by buying back my options even if they are far OTM & the dealer is behaving like a lawless bandit.


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## asterbin5 (Oct 1, 2015)

An especially complex area of risk involves taxes. If you are like most people, you understand how taxation works, generally speaking. When it comes to options, though, a few special rules apply that can decide whether a particular strategy makes sense.

Capital gains:- taxable profits from investments are broken down into short term or long term. The normal treatment of capital gains is determined by your holding period. If you own stock for 12 months or more and then sell, your profit is treated as long-term gain or loss; a lower tax percentage is applied than to short-term capital gains (gains on assets owned less than 12 months).


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## Spudd (Oct 11, 2011)

asterbin5 said:


> An especially complex area of risk involves taxes. If you are like most people, you understand how taxation works, generally speaking. When it comes to options, though, a few special rules apply that can decide whether a particular strategy makes sense.
> 
> Capital gains:- taxable profits from investments are broken down into short term or long term. The normal treatment of capital gains is determined by your holding period. If you own stock for 12 months or more and then sell, your profit is treated as long-term gain or loss; a lower tax percentage is applied than to short-term capital gains (gains on assets owned less than 12 months).


That's not true at all. That is true in the States, but not here.


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## humble_pie (Jun 7, 2009)

Spudd said:


> That's not true at all. That is true in the States, but not here.



Spudd is correct.

the bottom line: it's a good idea to always close your option positions so they are gains. Or losses, as the case may be. 

in canada, gains is gains. Only 50% is taxable. Never mind the US stuff.


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## The_Tosser (Oct 20, 2015)

humble_pie said:


> Never mind the US stuff.


lol My US friends are so blown away with our tax system RE Cap gains. 

They are getting hosed. More so in States like New Jersey. OMG they are crazy to live there as traders if there's no solid reason to do so. Insane.


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