How to Report Options Trading on Your Tax Return

Options trading involves buying and selling contracts that derive their value from an underlying asset, like a stock. These financial instruments provide the right, but not the obligation, to buy or sell the asset at a predetermined price within a specific timeframe. All profits and losses from these activities are subject to taxation and must be reported to the Internal Revenue Service (IRS), as failing to do so can lead to penalties and interest charges. The process requires careful record-keeping and an understanding of how different transaction outcomes are treated under tax law. Whether an option is sold for a profit, expires worthless, or is exercised to acquire the underlying stock, each scenario has a specific method for reporting that affects the calculation of capital gains or losses.

Required Tax Forms and Information

The primary document you will receive from your brokerage firm is Form 1099-B, “Proceeds From Broker and Barter Exchange Transactions.” This form summarizes your trading activity for the year, providing gross proceeds and the cost basis of the securities sold. Your broker sends a copy of this form to both you and the IRS.

Details on Form 1099-B include the proceeds from your sales in Box 1d and the cost basis in Box 1e. The cost basis represents your total investment in the option, including the premium and any commissions paid. Box 1g shows any wash sale loss that has been disallowed.

While Form 1099-B provides a summary, Form 8949, “Sales and Other Dispositions of Capital Assets,” is where you list the details of each individual transaction. This form acts as a detailed log for the description of the property sold, acquisition and sale dates, proceeds from the sale, and your cost basis.

The totals from your Form 8949s are carried over to Schedule D, “Capital Gains and Losses.” This schedule calculates your total net capital gain or loss for the year and separates gains and losses into short-term (assets held one year or less) and long-term (assets held more than one year) categories. These categories are taxed at different rates, and the final figure from Schedule D is entered on your main tax return, Form 1040.

Reporting Standard Option Trades

When you close an options position by selling a contract you previously bought, the transaction results in a capital gain or loss. You must report the date you originally purchased the option, the date you sold it, the total proceeds received from the sale, and your cost basis, which is the premium you paid plus any transaction fees. The difference between your proceeds and cost basis determines your reportable gain or loss.

A different scenario occurs when an option you purchased expires worthless. In this case, you have a capital loss equal to the premium you paid for the contract. To report this, you will list the expiration date as the “date sold” on Form 8949. The proceeds for this transaction are zero, and the cost basis is the amount you paid for the option.

If you are the writer of a call option and the holder exercises it, you are assigned the obligation to sell the underlying stock. The premium you received for selling the call option is added to the strike price of the stock to determine your total proceeds from the sale. This combined amount is used to calculate your capital gain or loss on the stock itself, not the option.

Conversely, if you write a put option and are assigned, you must purchase the underlying stock at the strike price. The premium you received for selling the put is not immediately reported as income. Instead, it reduces your cost basis in the stock you just acquired. This lower cost basis will lead to a larger capital gain or a smaller capital loss when you eventually sell the stock.

When you exercise a call option to buy stock, the premium you paid for the option is added to the strike price to establish the total cost basis of the acquired shares. If you exercise a put option to sell stock, the premium you paid for the put reduces the proceeds from the sale of that stock, which in turn affects the calculation of your capital gain or loss on the stock.

Navigating Special Tax Rules

The wash sale rule prevents taxpayers from claiming a loss on a security if they acquire a “substantially identical” one within 30 days before or after the sale. For options, this could mean selling a call option at a loss and then buying another call on the same stock with a similar strike price and expiration. The purpose of this rule is to stop investors from creating artificial losses for tax purposes.

When a wash sale occurs, the loss is deferred. The disallowed loss is added to the cost basis of the new position, which postpones loss recognition until the replacement security is sold. The holding period of the original position is also added to the holding period of the new one.

The straddle rules apply when an investor holds offsetting positions to reduce risk, such as holding both a long call and a long put on the same stock. These rules prevent a trader from deducting a loss on one leg of the straddle while holding an unrealized gain on the offsetting leg.

Like the wash sale rule, a loss on the losing leg of a straddle is deferred. The loss cannot be recognized for tax purposes until the offsetting position with the unrealized gain is closed. This prevents investors from selectively realizing losses while their overall economic position is protected.

Reporting Section 1256 Contracts

Certain options are classified as Section 1256 contracts and are subject to unique tax rules. These contracts primarily include broad-based index options, such as those on the S&P 500 (SPX) and Nasdaq 100 (NDX). Options on exchange-traded funds (ETFs) like the SPDR S&P 500 ETF (SPY), however, are generally not Section 1256 contracts and are taxed as standard equity options.

A primary feature of Section 1256 contracts is the mark-to-market rule. Under this rule, all open positions are treated as if they were sold at their fair market value on the last business day of the tax year. This means you must recognize any gains or losses on these contracts annually, even if you have not closed the positions.

These contracts also benefit from the 60/40 rule. Regardless of how long you held the contract, any capital gain or loss is treated as 60% long-term and 40% short-term. This can result in a lower effective tax rate compared to short-term gains on other securities, which are taxed at ordinary income rates.

Gains and losses from Section 1256 contracts are reported on Form 6781, “Gains and Losses From Section 1256 Contracts and Straddles.” The total net gain or loss from Form 6781 is then transferred to Schedule D, where it is combined with your other capital gains and losses.