Does anyone really know the tax details relating to options and the wash sale rules? I've read some of the tax code but do not completely understand its implications. Below is a sample scenario I'm attempting to understand: 5/17/07 Buy 100 shares of company XYZ at $14.75 5/17/07 Sell(Write) 1 contract June 07 $15.00 Call for $0.75 6/6/07 Stock closes at $16.50 6/7/07 Buy 1 contract June 07 $15.00 Call for $1.35 (loss) 6/7/07 Sell(Write) 1 contract July 07 $15.00 Call for $1.75 Questions Is the loss created by the 6/7/07 Buy disallowed completely for tax purposes or simply deferred? If it is deferred, is it deferred only until all option positions either expire or are closed and no other options are initiated within 30 days? Or is it deferred until the entire stock position underlying the option is closed (sold)? Does one have to sell the stock to realize the loss on the options? Hypothetical If the stock closed at $18.50 on 6/6/07 would this change the scenario? I assume since the option is now deep-in-the-money it wouldn't be a qualified covered call but does mean the loss is disallowed or deferred and what specific event ceases the deferral? Thanks,
My "guess"...if you own the underlying equity then the "loss" is deferred. Logically you have a gain so far. If you had chosen to let the stock get called your net gain is $1. You chose to roll for an additional 40 cents.. it doesn't matter how much the stock gains...you have already "sold" it for 15 dollars until you no longer roll. The trick is then at the end of the year if you have rolled each month do you have a net gain or loss? Again I believe if you still own the equity you still must defer . What happens if the stock tanks? You can't take a loss on the stock until you sell it but then you have to account for the net gain on the calls which (the way I read it) is by reducing the basis of the stock. So the simple way of accounting is...Bought the stock for $14.75 sold call for .75 in June...basis is now $14...bought back June call and sold July...net is .40 so basis is now $13.60 and so on. (don't forget that commission is added to the basis) So only upon selling the stock (or having it called away) is the transaction completed. The tax consequences I believe is that the equity is no longer considered held"long" term... In other words once sold you have to book the gain as short term even if you have held it for more than a year.
If your transactions don't straddle tax years and you don't have LT Cap Gains then you might consider just reporting each transaction individually. That is, all options and stocks would be reported with their own P/L without regard to them actually being covered calls, etc. By treating each transaction as an individual trade the tax forms are very simple (just list on Sched D). As I understand it Uncle Sam's objective is to disallow favorable tax treatment if you had an offsetting transaction. By listing all transactions individually you also forgo the favorable tax treatment but avoid the complicated forms. Of course, if you had LT Cap Gains or if you straddle tax years (e.g., wash sale) then it might be necessary to figure out the forms. Naturally the IRS might not like this shortcut, but since it probably produces the correct (and highest) tax calculation I would hope they wouldn't be too upset. One point, there are lots of tax regulations and I am not an expert so there could loopholes in the above technique. Don
Richard and Don, Thank you for your responses. They both raise a couple more questions in my addled head. Richard, regarding your statement "The tax consequences I believe is that the equity is no longer considered held"long" term... In other words once sold you have to book the gain as short term even if you have held it for more than a year." If you held the stock for a year after the option loss was realized might it be considered long term? Of course, the option loss would have to be deferred that entire time, right? Don, You say, "As I understand it Uncle Sam's objective is to disallow favorable tax treatment if you had an offsetting transaction. By listing all transactions individually you also forgo the favorable tax treatment but avoid the complicated forms." Excuse my ignorance but what favorable tax treatment are you referring to and what are the complicated forms associated with these? Thanks again for both of your previous responses,
I think so...at least "I" would but as Don points out they are many ways of interpretation of the tax code and you may get as many answers as the number of tax "experts" you consult However your July option sell then is a gain...is it not? Only if the stock tanked and didn't get called away will you be able to keep the stock without continued rolling. That is why the basis of the stock must change and why when options are tied to stock you cannot separate the two. If you are doing straight options, spreads etc then I believe Don is right that each transaction stands on its own. Its obvious the tax code was written by math majors who have no skill in writing
An example of favorable tax treatment would be Long Term Capital Gains. LT Cap Gains get taxed at a lower rate then short term gains. Depending on how deep ITM a covered call is the holding period to achieve LT status might be affected. Another example of favorable tax treatment are qualified dividends which are normally taxed at the LT Cap Gains rate. Again depending upon the depth of the CC these dividends may no longer qualify for the lower rate. Relative to the associated "complicated forms", perhaps they are not that complicated but if you do hundreds of transactions a year I suspect they can be burdensome. If the stock holding period was less than a year the LT Cap Gains would not apply anyway so you really don't lose anything by avoiding these forms and the associated record keeping. Although the tax computation without the forms should produce the same tax liability, if you are audited the IRS might not be happy that you avoided the forms. Don
I was looking into this subject myself this weekend. I started buying LEAPS this year but am also intrested in writing covered calls and writing shorter term options against the LEAPS. I found this info somewhat helpful; http://www.cboe.com/LearnCenter/Workbench/pdfs/TaxesandInvesting.pdf
LOL. I don't think that even the IRS understands the tax details relating to options! Be that as it may, my take is that the closing transaction is a capital loss (no deferral). But the sure fire way to avoid all of this hassle is to be out of the entire position by 12/31.