Special Edition: Reporting Options Trades for Taxes

This week, an entire Tax Forum about reporting options trades on your tax return. We won't discuss here what options are or how to use them. For that, browse past Options Forums in the archive. (By the way, we gave Options Forum the week off, since this column is killing two birds with one stone, so to speak.)

But before we get to options, a reminder: If you put your 1998 tax return on extension back in August, your drop-dead filing deadline is midnight Friday, Oct. 15. So if you have any under-the-gun questions, send them quickly to [e-mail]. We'll try to answer them in a bonus midweek Tax Forum.

Calls and Puts

The sale and purchase of calls and puts are reported just like those of stocks. Everything goes on Schedule D -- Capital Gains and Losses.

Don't forget to subtract commission fees from the sales price and add them to your original cost. And use the great chart on page 52 of Publication 550 -- Investment Income and Expenses for other tips on determining your sales price and basis.

If your options expire worthless or the underlying stock is called away, you need to make that clear.

If a purchased option has expired, enter the expiration date in column (c) and write "expired" in column (d).

If an option that you granted has expired, enter the expiration date in column (b) and write "expired" in column (e).

Futures or Index Options

If you trade regulated futures contracts, foreign currency contracts or nonequity options (options on stock index futures or broad-based stock indices, such as the S&P 500 index), reporting rules are a little different.

Gains and losses on these securities follow the 60/40 rule (see Section 1256 of the tax code) and must first be reported on Form 6781-- Gains and Losses From Section 1256 Contracts and Straddles.

The 60/40 rule says that 60% of your gain or loss on these contracts is treated as long term and 40% is short term, regardless of the actual time they're held. In addition, if you have an open position in one of these securities at year-end, you must pretend that it's sold (or, mark it to market, in tax lingo) on Dec. 31.

Form 6781

All this goes on Part I of Form 6781, and it really is pretty straightforward. You just need to fill in the description of the security and the corresponding gain or loss. No dates are needed. Once you work through the form, the final numbers from lines 8 and 9 are then transferred to Schedule D, lines 4 or 11, respectively.

If you have straddle positions, Part II of this form is all for you. You've just got to follow the instructions here. Good luck.

Shorting Against the Box

If you attempted to go short against the box, but the constructive sale rule kicked in, just report the loss like any other sale of stock. For the sale date, use the date you entered the long position. So if you bought the long stock on Oct. 6 and didn't meet the constructive sale rules, then use Oct. 6 as the sale date on Schedule D. It wouldn't hurt to include "constructive sale" in the description column as well.

Wash-Sale Rule

If a loss on the sale of a stock or option is disallowed as a result of the wash-sale rule, you have a two-line reporting process ahead of you.

First, report the loss as you would any other loss on Schedule D. Show the full amount of the loss as a negative in column (f).

But on the next line, just enter "wash sale" in the description column (a), and enter the loss as positive number in the gain column (f). That's all you need for that line item.

Short Positions

Only when a short position is closed is there a taxable event. So you only report short sales in the year you cover them. If you are holding an open short position at year-end, you will not owe tax on it.

But if you do have open positions on Dec. 31, the gross proceeds reported on your Form 1099B -- Proceeds from Broker and Barter Exchange Transactions will be greater than the amount your report on your tax return.

You'll need to attach a reconciliation schedule. It can be a plain sheet of paper with your name and Social Security number on it. Write "see attached schedule" in column (a), then attach a form that should look something like this:

Gross proceeds from Broker .......... xxxx
Less short sales to be reported next year ....... yyyy
Total reported on Schedule D ........ zzzz

Show the final number as total sales in column (d) on Schedule D.

Attachment Miscellany

Since option trades are not reported on Form 1099B but must be reported on your tax return, you should do a simple reconciliation.

If the total sales price you're reporting on your tax return is larger than the amount reported on your 1099B, "you're probably not going to have a problem," says Willy Weinstein, a tax research specialist at H&R Block in Kansas City, Mo. If that's the case, you're paying more tax than the Internal Revenue Service thinks you should.

But if the amount you report is less (i.e., you're a really bad options trader), attach a simple schedule explaining the difference. Be sure to put your name and Social Security number on it. Then show the difference as a lump sum. Say you're down $2,000. Just show that $2,000 as "difference due to option trading losses." There's no need to show every transaction. You'll just confuse the IRS.

Remember, if all you do is trade options, you won't get a Form 1099B at all. So, again, just attach a quick explanation of your total sales proceeds (i.e., "sales from options trading").

As a general rule, keep all your trading records, including your purchase and sales slips, for a minimum of three years after the due date of your tax return. "But if something has an effect on future years, then hang on to everything as long it is material to your tax return," Weinstein says.

Keep in mind that you can just attach your own trading schedule. Make sure it contains all the same info as Schedule D. Then just transfer the grand totals to Schedule D and write "see attached schedule" in the description column. Just write "various" in the date columns.

Be sure to check out Mike Bauer's Schedule D for more examples of these reporting tips. And if all else fails, there's always the IRS' instructions for Schedule D.