31.6 Sale of an Option

The tax treatment of the sale of an option depends on the tax classification of the property to which the option relates.

If the option is for the purchase of property that would be a capital asset in your hands, profit on the sale of the option is treated as capital gain. A loss is treated as a capital loss if the property subject to the option was investment property; if the property was personal property, the loss is not deductible. Whether the gain or loss is long term or short term depends on your holding period.

If the option is for a “Section 1231 asset” (44.8), gain or loss on the sale of the option is combined with other Section 1231 asset transactions to determine if there is capital gain or ordinary loss.

If the option relates to an ordinary income asset in your hands, then gain or loss would be ordinary income or loss.

If you fail to exercise an option and allow it to lapse, the option is considered to have been sold on the expiration date. Gain or loss is computed according to the rules just discussed.

The party granting the option realizes ordinary income on its expiration, regardless of the nature of the underlying property. If the option is exercised, the option payment is added to the selling price of the property when figuring gain or loss.