How Options Are Taxed
Understand the tax implications of options trading. Learn about short-term vs long-term gains, wash sales, and how to report your trades.
How Options Are Taxed
Understanding the tax implications of options trading helps you plan better and avoid surprises at tax time. Here's what wheel traders need to know.
Short-Term vs Long-Term Capital Gains
Option premiums are typically taxed as short-term capital gains:
| Holding Period | Tax Rate | Applies To |
|---|---|---|
| Short-term (< 1 year) | Ordinary income rate (up to 37%) | Most options trades |
| Long-term (> 1 year) | 0%, 15%, or 20% | Rarely applies to options |
Important: The holding period for options is from when you open to when you close the position - usually days or weeks.
Taxing Different Scenarios
1. Selling a Put That Expires Worthless
- Premium is short-term capital gain
- Recognized in the year the option expires
- Example: Sell put for $150 → $150 short-term gain
2. Selling a Put and Getting Assigned
- Premium is NOT taxed separately
- Premium reduces your cost basis in the stock
- Tax occurs when you eventually sell the stock
Stock cost basis = Strike price - Premium received
Example: $50 strike - $1.50 premium = $48.50 cost basis
3. Selling a Covered Call That Expires Worthless
- Premium is short-term capital gain
- Recognized in the year the option expires
- Separate from any stock gains/losses
4. Selling a Covered Call and Getting Assigned
- Premium is added to your sale proceeds
- Combined with stock gain/loss
Sale proceeds = Strike price + Premium received
Example: $55 strike + $1.25 premium = $56.25 sale price
5. Buying Back an Option to Close
- Net of premium received minus buyback cost
- If buyback > premium received = short-term loss
- If buyback < premium received = short-term gain
The Wash Sale Rule
The wash sale rule prevents you from claiming a loss if you buy a "substantially identical" security within 30 days before or after the sale.
For Options:
- Selling a stock at a loss and immediately selling puts on it = wash sale
- The loss is added to your new cost basis, not deducted now
Example:
- Sell stock at $45 (bought at $50) = $5 loss
- Within 30 days, sell a put that gets assigned at $45
- Wash sale: The $5 loss is added to your new cost basis ($45 + $5 = $50)
How to Avoid:
- Wait 31 days before trading the same underlying
- Trade different (not substantially identical) stocks
- Be aware of your 30-day windows
Tracking for Taxes
Keep records of:
| Item | Why It Matters |
|---|---|
| Trade dates | Determines holding period |
| Premium received/paid | Gains calculation |
| Assignment dates | Stock cost basis |
| Closing prices | Net gain/loss |
| Commissions | Reduces gains/increases losses |
Form 1099-B and Schedule D
Your broker will send a 1099-B showing:
- Proceeds from all sales
- Cost basis (if known)
- Short-term vs long-term classification
You'll report on Schedule D:
- Aggregate short-term gains/losses
- Aggregate long-term gains/losses
- Net capital gain or loss
Tax Planning Strategies
1. Tax-Loss Harvesting
- Realize losses to offset gains
- Be mindful of wash sale rules
- Don't let tax tail wag the trading dog
2. Timing Option Expirations
- December expiration = current year tax
- January expiration = next year tax
- Can shift income between years
3. Consider Retirement Accounts
- Options in IRAs = no current tax
- Roth IRA = potentially tax-free
- Check your broker's rules on options in retirement accounts
Common Tax Mistakes
- Not tracking assignments - leads to incorrect cost basis
- Ignoring wash sales - IRS will catch this
- Missing the exercise/assignment link - premium and stock are connected
- Forgetting commissions - they're deductible
- Poor record keeping - makes tax time painful
Example: Full Wheel Cycle Tax Treatment
Trade 1: Sell Put
- Sell $50 put for $1.50
- Assigned at $50
- Tax: None yet (premium reduces cost basis)
- Cost basis: $50 - $1.50 = $48.50
Trade 2: Sell Covered Call
- Sell $55 call for $1.25
- Called away at $55
- Tax: Short-term gain on call + stock gain
Call premium: $1.25 (short-term gain)
Stock sale: $55 - $48.50 = $6.50 gain
Total taxable: $7.75 per share short-term gain
Consult a Tax Professional
Options taxes can be complex, especially with:
- High volume of trades
- Multiple rolls and adjustments
- Wash sale situations
- State tax considerations
Consider working with a tax professional familiar with options trading.
In the next lesson, we'll show you how to use our option screener to find the best opportunities.