Stocks, Bonds etc. -> Investing Tax Issues -> Call and put options

Tax treatment of income from investments in call and put options

Income Tax Act S. 49

For most people, the gains and losses from options are taxed as capital gains (on capital account).  However, if you are in the business of buying and selling stock, then your gains and losses from options will be treated as income (on income account - see capital or income).

Gains or losses realized by a writer (seller) of naked (uncovered) options are normally treated as income.  However, according to IT-479R, paragraph 25(c), CRA will allow these to be treated as capital gains, provided this practice is followed consistently from year to year.

For taxpayers who record gains and losses from options as income, the income from options sold (written) is reported in the tax year in which the options expire, or are exercised or bought back.  When call options are purchased and subsequently exercised, the cost of the options is added to the cost base of the purchased shares.  If the call options are not exercised, the cost is deducted in the tax year in which the options expire.  If the call options are closed out by selling them, the proceeds are included in income, and the original cost is written off, in the tax year in which the options are closed out.  When put options are purchased, the cost is written off in the year in which the options expire, are exercised, or are closed out by selling them.

For taxpayers who record gains and losses from options as capital gains, the timing is a little trickier for options which have been sold.  The following table shows the timing of the recording of gains and losses on options that have been sold or purchased.  This table has been prepared based on the information in the CRA interpretation bulletin IT-479R Transactions in securities.

As you can see in the table, when call and put options sold are being recorded as capital gains, the gain is recorded in the taxation year in which the options are sold.  However, if the options are then exercised in the next taxation year,  the capital gain from the previous year must be reversed, and either added to the proceeds from the sale of shares (call option), or deducted from the cost basis of shares purchased (put option).  To revise the capital gains from the previous year, a T1Adj would have to be filed.  See our article on changing your tax return after it has been filed.

Usually, the taxpayer would benefit from filing the T1Adj.  However, if the amount is not significant, and if a tax preparer is being paid to do the taxes,  there may be little benefit to filing the T1Adj.  The only problem is that the Income Tax Act requires the options proceeds to either be added to the proceeds from the sale of shares (call option), or deducted from the cost basis of shares purchased (put option) when the option is exercised.  This applies even if the proceeds were taxed in a previous year, and no T1Adj was filed to reverse this.  Therefore, double taxation will occur if the T1Adj is not filed.

We traded options for about a decade, and in the end finally decided to quit, because

Tax Tip:  Leave option-trading to the professionals.