There are two basic types of options. A “call option” is an option that gives the option holder the right to purchase a property at a set price (sometimes called the exercise price or strike price). A “put option” is an option that gives the option holder the right to sell a property at a set price. In either case, because the right is an “option”, it obviously is not mandatory for the option holder to exercise it.
The following is a summary of the income tax rules that apply to options. (We are assuming you are not in the business of selling options.)
Grantor of call option
If you grant (sell) a call option to someone, the amount you receive for the option is considered a capital gain, half of which is included in your income as a taxable capital gain.
If the option is subsequently exercised by the option holder, so that you must sell the underlying property, your proceeds of disposition of the property will include the amount previously received for the grant of the option. The original gain on the grant of the option will be revised to nil. If the grant of the option took place in a previous year, you are allowed to amend the previous tax return to take this revision into account.
Purchaser of call option
If you purchase an option to acquire property, there is no immediate tax consequence. If the option expires without being exercised, you will have a capital loss at that time equal to the amount you paid for the option, and half of that will be an allowable capital loss.
However, if you exercise the option and purchase the property, the amount you paid for the option will be added to your cost of the property.
Example of call option
This year, you grant a call option to Mr. Option Holder for $2,000. The option gives Option Holder the right to purchase certain property from you for $50,000 over the next 18 months. Next year, within the 18-month period, Option Holder exercises the option and buys the property for $50,000 from you. Your cost of the property was $30,000.
Your tax results: On the grant of the option, you will initially have a $2,000 capital gain and $1,000 of that will be included in your income as a taxable capital gain. However, since the option was later exercised, this taxable capital gain will be revised to nil (and you can amend this year’s return if you have already filed it). Next year, your proceeds of disposition of the property will be $52,000, resulting in a $22,000 capital gain, of which $11,000 will be included in your income as a taxable capital gain.
Option Holder’s tax results: Option Holder’s cost of the property will include the $50,000 paid for the property plus the $2,000 paid for the option, for a total cost of $52,000.
Grantor of put option
If you grant (sell) a put option to someone, the amount you receive for the option is considered a capital gain, half of which is included in your income as a taxable capital gain.
If the option is later exercised by the option holder, so that you must buy the underlying property, your cost of the property will be reduced by the amount previously received for the grant of the option. The original gain on the grant of the option will be revised to nil. If the grant took place in a previous year, you are allowed to amend the previous tax return to take this into account.
Purchaser of put option
If you purchase an option to sell property, there is no immediate tax consequence. If the option expires without being exercised, you will have a capital loss at that time equal to the amount you paid for the option, and half of that will be an allowable capital loss.
However, if you exercise the option and sell the property, the amount you paid for the option will reduce your proceeds of disposition of the property.