Is an Expired Worthless Option a Capital Loss?
An expired worthless option creates a capital loss. Its tax character is determined by the option's own holding period, a key detail for accurate reporting.
When a purchased stock option expires worthless, it generates a capital loss for the holder. This loss is equivalent to the premium paid for the option plus any associated transaction costs. Taxpayers can use this capital loss to offset capital gains and, in some cases, a portion of their ordinary income. The rules governing these losses depend on the holding period of the option.
Determining the Type of Capital Loss
For tax purposes, an option that expires worthless is treated as if it were sold for zero dollars on its expiration date. The resulting capital loss is calculated by taking your cost basis—the premium you paid to acquire the option plus any commissions or fees—and subtracting the zero-dollar proceeds. The character of this loss, whether short-term or long-term, depends on how long you held the option contract.
The holding period is the primary determinant in classifying the loss. If you held the option for one year or less, the expiration results in a short-term capital loss. If you held the option for more than one year, it is a long-term capital loss. This distinction is based on the option’s holding period, not the holding period of the underlying stock.
Most standard stock options have expiration dates ranging from a few weeks to several months, so the vast majority of losses from expired options are classified as short-term. It is uncommon for retail investors to purchase and hold options, known as LEAPS (Long-Term Equity AnticiPation Securities), that last for more than a year. An expired worthless option almost always translates to a short-term capital loss.
Reporting an Expired Option on Your Tax Return
To claim a loss from an expired option, you must report it on specific IRS forms. The primary document is Form 8949, Sales and Other Dispositions of Capital Assets. The information from this form is then summarized and carried over to Schedule D, Capital Gains and Losses, which is filed with your tax return.
When completing Form 8949, you will use Part I for short-term losses, which is where most expired options are reported. In column (a), provide a description of the option, such as “Expired XYZ Call.” In column (b), enter the date you originally purchased the option.
For column (c), the “Date Sold or Disposed,” you should enter the option’s expiration date. In column (d), for “Proceeds,” you will enter $0. Column (e) is for your cost basis, which is the premium you paid plus any transaction fees. The resulting loss, shown in column (h), will be the same as your cost basis. After completing Form 8949, the totals are transferred to the corresponding sections of Schedule D.
Special Tax Rules for Options
Certain tax rules can affect the treatment of losses from expired options. The wash sale rule can disallow a loss if you acquire a “substantially identical” security within 30 days before or after the date the loss is realized. If your option expires worthless and you purchase a very similar option or the underlying stock within the 61-day window, the IRS may not permit you to claim the loss immediately. Instead, the disallowed loss is added to the cost basis of the new position.
An exception to the standard holding period rules applies to Section 1256 contracts. These include broad-based index options, such as those on the S&P 500. Under Section 1256, these contracts are marked-to-market at the end of the year, and any gain or loss is treated as 60% long-term and 40% short-term, regardless of how long you actually held the contract.
The tax treatment for the person who sold or “wrote” the option is the mirror image of the buyer’s. When an option expires worthless, the writer of the option realizes a short-term capital gain. This gain is equal to the premium they received for selling the option. This income is always considered short-term, regardless of the option’s duration.