Hello, Suppose you have held a stock/etf for about 9 months. You are happy with the gains, but you don't want to sell immediately. You want to get to 12 months' hold time so you can get taxed at the capital gains rates rather than the ordinary income rate. I was thinking you could put a tight at-the-money collar around the stock/etf for a few months. You might have to pay some money, and your shares might get called away. But the tax benefits could be substantial, and you might collect a dividend along the way. Is this what people do sometimes? It seems reasonable.
http://www.cboe.com/advisors/tax-issues How are covered calls taxed? The IRS wants to make sure investors do not use deep-in-the-money options when writing covered calls since that would allow investors to possibly: Mismatch gains and losses in different tax years Substantially reduce the risk of holding positions As a result, the IRS developed the Qualified Covered Call (QCC) rules. Generally, if an investor is seeking to grow the underlying security position to long-term capital gain status, while preserving Qualified Dividend Income (QDI), they should limit their call writing activities to at-the-money and out-of-the-money options with 30 days or more until expiration. However, if an investor utilizes calls with greater than 12 months to expiration, they will have to adjust the Lowest Qualified Benchmark (LQB) by 2% per quarter. The call premium received from a QCC will be recognized as a short-term capital gain if the option expires or the investor enters into a closing transaction. However, if the option is assigned, the premium will be taxed in accordance with the underlying stock position. How are protective puts taxed? If your position in the stock is not eligible for long-term capital gains treatment and you purchase a protective put, your holding period is eliminated. Unfortunately, your holding period will not restart until the put is disposed. However, a put purchase will not affect your holding period if either: The stock is already eligible for long-term capital gains treatment The put is “married” to the stock purchase In either scenario, Qualified Dividend Income (QDI) is forfeited while the put is in place.
If the position were big enough, would a short hedge in the ES or NQ accomplish similar financial objective without all of the "qualifications"?
Thanks, Robert! I'm not trying to get the option premium taxed at a lower rate. I am actually not trying for any premium at all (although on some of them I might get a few pennies). I'm just trying to protect the underlying share value for a year or two. That way I can sell the shares over time when I'm ready rather than all at once or when a sudden market swing causes duress. I have some stocks that have had a good run up, but I'm not ready to do much with them. So collaring can essentially "park" them for a while. I'm trying to guard against losses rather than make any sort of money (although I'll still get the dividends while I still own the shares). If I make any sort of small option gain between the call/put spread, I just assume it is a short-term capital gain and pay it as such. All of my calls are slightly out of the money. I'm doing near out of the money calls and near out of the money puts. So if the stock trades at 25, I'm looking to do something like sell the 26 call and buy the 24 put. There might be some obscure way to increase gains buy writing a deep in the money covered call. That's beyond my pay grade for now. I'm happy just to wrap the thing with a simple high-low.
It seems to me that the IRS is not happy with your hedge to avoid short term gains. I'm not a tax expert, Just passing along the link.
I'm not a tax expert, but I've found this link helpful: http://g2ft.com/resources/constructivesales.html. I remember reading somewhere else that it's a gray area how tight a collar can be before it constitutes a constructive sale. Have a look at the Closed Transaction Exception described on that page. If you've held the stock for 9 months, you could temporarily hedge and then continue unhedged for another 3 months to reach a 1 year holding period. Dividends while you are hedged would not be qualified.
Thanks, Robert. This is a great point. What does "Qualified Dividend Income (QDI) is forfeited while the put is in place." mean? I talked to a brokerage and an accountant. Nobody has seemed to have heard of this. The brokerage says they still pay out a dividend whether a stock has a put or a collar on it. Are we supposed to keep track of the dividends in a collared stock, and then mail the dividends to the IRS? I'm not quite following this.
Qualified dividends are those which are taxed as long term gains. Not qualified are those taxed as ordinary income (short term gains).
https://www.irs.gov/publications/p550#en_US_2016_publink100010081 See "Holding period reduced where risk of loss is diminished" under "Qualified Dividends." The dividend isn't "forfeited," the qualified status is. You keep the dividend, but it is not qualified and is taxed as a ordinary income.