A call option is an option under which the holder has the right, but not the obligation, to buy a particular property at a set price (exercise price). On the other hand, a put option gives the holder the right to sell a property at a set price (also, the exercise price).
Depending on the terms of the option, it may be exercised by the holder (so that the property is sold or purchased, as the case may be) over a period of time or at a specific set time. If the option is not exercised, it normally just expires and the property will not be sold or purchased under the option.
Call options – tax position of holder
There is no tax consequence to the holder until the holder exercises the option and acquires the property. At that time, the holder’s cost of the property, for tax purposes, will include the exercise price to acquire the property plus the holder’s cost of the option.
If the holder does not exercise the option and it expires, at that time of expiration the holder will have a capital loss equal to the amount paid for the option.
Call options – position of grantor of option
On granting the option, the grantor will have deemed proceeds of disposition equal to the amount received from the holder for the option. In most cases, an indivi-dual grantor’s cost of the option is deemed to be nil. As such, the grantor will realize a capital gain equal to the amount received for the option. Half of the capital gain is included in income for tax purposes, as a taxable capital gain.
However, if the option is exercised by the holder, the grantor’s initial grant of the option will be deemed not to result in a disposition or capital gain. Instead, the exercise price under the option plus the amount received for the grant of the option will form the grantor’s proceeds of disposition of the property. If the exercise takes place in a year subsequent to the initial year of the grant of the option, the CRA will reassess the initial year and eliminate the initial gain (described in the preceding paragraph).
Put options – tax position of holder
There is no tax consequence until the holder exer-cises the option and sells the subject property. Upon exercise, the holder’s cost of the option is subtracted from the proceeds of disposition of the property, effectively reducing any gain (or increasing any loss) on that disposition.
If the option is not exercised and expires, at that time the holder will have a capital loss equal to the amount paid for the option.
Put options – tax position of grantor of option
As above, upon granting the option, the grantor will have proceeds of disposition equal to the amount received from the holder for the option, and will generally realize a capital gain equal to that amount.
If the put option is exercised by the holder, such that the grantor must purchase the property subject to the option, the grant of the option is deemed not to have occurred, so the gain in the preceding paragraph will be nil. Instead, on the exercise, the grantor’s cost of the purchased property is reduced by the amount received for the option. As above, if the exercise takes place in a year subsequent to the initial year of the grant of the option, the CRA will reassess the initial year and eliminate the initial gain.
Example of Call Option
Last year, Mr. B granted you an option to purchase some commercial real estate from him at an exercise price of $200,000. Mr. B’s cost of the real estate was $100,000. You paid $5,000 for the call option. This year, you exercised the option and purchased the real estate for $200,000.
Your tax treatment: Your cost of the real estate will include the $5,000 paid for the option plus the $200,000 exercise price paid for the real estate pursuant to the option, for a total of $205,000.
Mr. B’s tax treatment: Last year, he had an initial capital gain of $5,000. However, in this year, his proceeds of disposition of the real estate will include the $200,000 exercise price received plus the $5,000 received for the option, or $205,000. As a result, he may have a gain this year equal to his $205,000 proceeds minus his $100,000 cost, or $105,000. The CRA should then reassess last year to remove the initial $5,000 gain reported in that year.
Example of Put Option
Last year, Mr. B granted you a put option that allows you to sell some commercial real estate to him (i.e., force him to buy it) at an exercise price of $200,000. Your cost of the real estate was $100,000. You paid $5,000 for the put option. This year, you exercised the option and sold the real estate to Mr. B for $200,000.
Your tax treatment: Your $200,000 proceeds of disposition of the property will be reduced by the $5,000 you paid for the option, for a total of $195,000. As such, you have a capital gain of $95,000, half of which is included in your income as a taxable capital gain.
Mr. B’s tax treatment: Last year, he had an initial capital gain of $5,000. However, this year, his $200,000 cost of the real estate will be reduced by the $5,000 he received for the option, for a total cost of $195,000. The CRA will then reassess last year to remove the initial $5,000 gain reported in that year.
Employee stock options
The above tax rules do not govern employee stock options, e.g. those granted to employees by their employer corporations. The employee stock option rules were discussed in our May 2015 Tax Letter.
Last year, Mr. B granted you an option to purchase some commercial real estate from him at an exercise price of $200,000. Mr. B’s cost of the real