When exercising an option, you purchase stock at a price that is preset in the option contract. A sell to cover transaction involves exercising the purchase option and simultaneously selling enough of the acquired stock to recover your costs for the option purchase, brokerage fees and taxes.
Selling stock immediately upon acquiring it from an option exercise is reported as a short-term capital gain for income tax purposes. The gain is the sales proceeds minus your tax basis. The cost to exercise the option plus the original cost of purchasing the option is the tax basis.
Calculating Tax Basis
Add the cost to exercise the option and purchase price of the option contract to determine the total tax basis.
Divide the total tax basis by the number of shares acquired in the option exercise. This is the tax basis per share.
Multiple the tax basis per share by the number of shares sold in the sell to cover transaction. This is tax basis of the sold shares.
Reporting Taxable Income
Record a description of the stock in Column (a) of Line 1 on Schedule D.
Place the date that you exercised the option in Column (b) that’s labeled “Date acquired.”
Enter the sale date of the stock in Column (c) that’s labeled “Date sold.” This is the same as the exercise date for a sell to cover transaction because the sale is simultaneous to exercising the option.
Input the sales proceeds for the stock sold to cover in Column (d) that’s labeled “Sales price.” Then, state the tax basis of the sold shares in Column (e) that’s labeled “Cost or other basis.”
Complete Column (f) as indicated on Schedule D by subtracting Column (e) from Column (d). This is the taxable gain.