Special income tax rules apply to options, whether you purchase them or sell or grant them.
First, some terminology. A “call option” on a property provides the holder of the option with the right to buy the property at a set price, sometimes called the exercise price. In contrast, a “put option” on a property provides the holder with the right to sell the property at the exercise price.
Purchase and sale of call option
Generally, there are no immediately income tax consequences for the purchaser of a call option, except that the purchase price of the option becomes the purchaser’s adjusted cost base of the option. If the option expires and is not exercised, the purchaser will have a capital loss in the year of expiration equal to the purchase price, and half of that will be an allowable capital loss.
Exercise of call option
If the option is exercised and the property is acquired, the purchase price of the option is added to the adjusted cost base of the property for the purchaser.
For the grantor, the amount received for the option will be added to its proceeds of disposition of the property, which will generate a capital gain or loss. In this case, the grantor’s capital gain on the sale of the option (see above) will be reversed. If the sale of the option was in an earlier year, the grantor can amend the earlier year’s tax return to delete the previously reported gain and claim a tax refund, if applicable.
Example
In 2018, John purchases a call option from Mary for $10,000. The option provides John with the right to purchase Mary’s shares in a private corporation for $200,000 until the end of 2019. Mary’s adjusted base cost of the shares was $120,000.
In 2019, John exercises the option and purchases the shares for the exercise price of $200,000.
Results: In 2018, Mary will have a capital gain on the grant of the option equal to $10,000 and therefore a taxable capital gain of $5,000.
In 2019, Mary will have proceeds of disposition of $210,000, which is the $200,000 exercise price plus the $10,000 she received for selling the option, for a total of $210,000. The 2018 capital gain will be reversed / deleted if she amends her 2018 return.
Therefore, in 2019 Mary will have a capital gain of $90,000 ($210,000 proceeds minus her adjusted cost base of $120,000), and half of that, or $45,000, will be included in her income as a taxable capital gain.
John will acquire the property at an adjusted cost base of $210,000, which is the $200,000 exercise price plus the $10,000 amount paid for the option.
Purchase and sale of put option
The grantor of a put option will have proceeds of disposition equal to the amount received for granting the option, and therefore will have a capital gain, half of which will be a taxable capital gain included in the grantor’s income.
There are no immediately income tax consequences for the holder of the put option, except that the purchase price of the option becomes the holder’s adjusted cost base of the option. If the option expires and is not exercised, the holder will have a capital loss in the year of expiration equal to the purchase price, and half of that will be an allowable capital loss.
Exercise of put option
If the holder of the option exercises the option and sells the underlying property, its proceeds of disposition for the property will equal the exercise price minus the adjusted cost base of the option.
The grantor of the put option, who will purchase the underlying property upon exercise of the option, will have an adjusted cost base in the property equal to the exercise price minus the amount it received for the option. If the option was granted in an earlier year, the grantor can have the earlier year’s tax return amended to take out the previously reported gain (see above) and claim a tax refund, if applicable.
Example
In 2018, John grants a put option to Mary for $10,000. The option provides Mary with the right to sell her shares in a private corporation to John for $200,000 until the end of 2019. Mary’s adjusted base cost of the shares was $120,000.
In 2019, Mary exercises the option and sells the shares to John for the exercise price of $200,000.
Results: In 2018, John will have a capital gain on the grant of the option equal to $10,000 and therefore a taxable capital gain of $5,000.
In 2019, Mary will have proceeds of disposition of $190,000, which is $200,000 exercise price minus the $10,000 she paid for the option. Therefore, in 2019 Mary will have a capital gain of $70,000 ($190,000 proceeds minus her adjusted cost base of $120,000), and half of that, of $35,000, will be included in her income as a taxable capital gain.
John will acquire the property at an adjusted cost base of $190,000, which is $200,000 exercise price minus the $10,000 he received for the option. The 2018 capital gain will be reversed / deleted if he amends his 2018 return.