This Tax Season, Know Your Options

Exercised options. If the option is exercised, add the premium to the sales proceeds of the stock to determine gain or loss on the sale of the stock. Whether the gain or loss is short-term or long-term depends on the holding period of the stock.

Expired options. If the holder doesn't exercise the option before the expiration date, simply report the premium you collected as a short-term capital gain in the year the option expires.

Wash Sale Rule

You didn't think we'd get through a story on investing and taxes without some mention of the wash sale rule, did you? This rule disallows any deduction on a loss from the sale of a security if the identical security was purchased within 30 days before or after the sale date. The rule also includes options held that would enable you to acquire the identical security.

A loss on a covered call (one in which the taxpayer writes a call option for stock that's already in his or her own portfolio) that has a strike price below the current stock price might be considered a long-term capital loss. If selling the stock would have resulted in a long-term gain at the time the option was exercised by the holder (causing the loss on the option), you're allowed to claim a long-term loss.

The holding period of the underlying stock, though, doesn't include the time it was hedged. So you'll have to subtract from the holding period the length of the option contract.

And the Internal Revenue Service's parting shot on the matter -- year-end losses from covered call options are not deductible unless the stock is held uncovered for more than 30 days after the date on which the option is closed.

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