There are generally two types of options – a call option and a put option.
A call option gives the holder of the option the right to purchase a property at a set price (“exercise price”) at or up to a certain date. Conversely, a put option gives the holder of the option the right to sell a property at an exercise price at or up to a certain date.
Grant of option
For income tax purposes, if you grant or sell an option, you have a deemed disposition of the option and your adjusted cost base is deemed to be nil. As such, you will have a capital gain equal to the sales price of the option, and one-half of that will be included in your income as a taxable capital gain. The purchaser of the option will have an adjusted cost base in the option equal to what they paid you for it, i.e. the purchase price of the option.
Exercise of option
The holder of the option may exercise the option and either purchase (call) or sell (put) the property that is subject to the option. Upon the exercise, the tax consequences of the initial grant of the option, described above, are essentially negated (once the option is exercised, the former grant of the option is deemed not to have been a disposition of property). Furthermore, the exercise of the option is not itself a disposition of property.
Instead, on the exercise of a call option, the vendor of the property, who granted the option, includes in their proceeds of disposition of the property the proceeds received on the grant of the option. If the exercise of the option is in a taxation year after the year in which the option was granted (“grant year”), the vendor can amend the tax return for the grant year to exclude the proceeds that were initially received for the option. The purchaser of the property, who paid for the option, includes in their adjusted cost base of the property their cost of the option.
On the exercise of a put option, the purchaser of the property, who granted the option, subtracts from their adjusted cost base of the property the amount they received for the option. As with a call option, if the exercise takes place in a year after the grant year, the purchaser can amend the tax return for the grant year to exclude the proceeds received on the grant of the option. The vendor, who paid for the option, subtracts from their proceeds of disposition of the property their cost of the option.
Expiration of option
If a call or put option expires without being exercised, the holder of the option has a deemed disposition for nil proceeds. As such, the holder will have a capital loss, one-half of which will be an allowable capital loss.
In this case, the initial grant of the option stands, so that the grantor of the option will still include the proceeds received for the option in the grant year.
Example (call option)
Bill grants a call option in respect of a property to Clara, with an exercise price of $100,000. Clara pays $5,000 for the option.
Initial tax consequences:
Bill has a deemed disposition for $5,000, resulting in a $2,500 taxable capital gain. Clara has an adjusted cost base in the option of $5,000.
Assume next that Clara exercises the option and buys the property for $100,000.
New tax consequences:
Bill’s previous deemed disposition of the option is deemed not to have occurred. Instead, Bill includes the $5,000 received for the option in his proceeds of disposition for the property, which becomes $105,000. He will have a capital gain or loss, depending on his cost of the property.
Clara’s adjusted cost base of the property includes the $5,000 she paid for the option, so her adjusted cost base becomes $105,000.
Assume instead that Clara does not exercise the option and it expires.
Expiration tax consequences:
At the time the option expires, Clara will have a deemed disposition for nil proceeds, resulting in a $5,000 capital loss. Bill’s previous deemed disposition of the option remains unchanged.