Can I Claim the Loss on Unexercised Stock Options?

Can I Claim the Loss on Unexercised Stock Options?
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No one likes to take a loss on an investment, but it’s bound to happen from time to time. When you trade options, losses will occur when you can’t profitably exercise the options (use it to buy or sell the underlying stock) before the options’ expiry date. All you can do is let the option contract expire and take the loss. It’s some consolation that you can claim any loss on unexercised stock options on your tax return.

Exercising Stock Options

Stock options must be “in the money” to be exercised for a profit. For call options, this means the market price of the stock must be greater than the exercise price. You are then able to buy the shares for less than you can sell them for on the market. For put options, the market price must be less than the exercise price. That way, you can buy the shares on the market and sell them at the higher exercise price.

If the stock options are not in the money by the date they expire, you simply let the options expire unexercised.

Unexercised Stock Options and Taxes

When you purchase a stock options contract, you pay a premium to the option's writer who issued the contract. Your loss on options when you do not exercise stock options is the amount of the premium plus any transaction fees.

A loss on options is a capital loss. If you held the options for one year or less, it is a short-term capital loss. You have a long-term capital loss if the options were held longer than one year. Use Schedule D Part I or Part II to report the amount of the short-term loss, plus the purchase and expiration dates of the options transaction.

Offsetting Options to Hedge Against Loss

Sometimes investors use stock options to hedge an existing position in a stock. This strategy, called a straddle, is executed by purchasing an offsetting options contract. For example, you might buy put options to protect gains on a stock you own but are not ready to sell for some reason. If you still hold the stock when the options expire, you can only claim that part of the loss that is in excess of any unrealized gain on the stock.

You will have to wait until the year you sell the stock to claim the remainder of the loss from the unexercised stock option. However, if you have sold the stock by the end of the year the option expires, you can claim the entire loss in that tax year.

Capital Gains Tax on Profits

If your stock options end up in the money and you exercise them for a profit, it is treated as a capital gain for tax purposes. Your gain is equal to the proceeds from the sale of the stock minus your cost basis. Cost basis, or tax basis, consists of the price paid for the stock, the premium, and any transaction fees.

The tax status depends on how long you actually own the stock, not including the time you held the options prior to exercising them. You must hold the stock itself for more than one year for the profit to qualify for long-term capital gains tax rates. Otherwise, the gain is taxed as a short-term capital gain.

According to the IRS, long-term capital gains are taxed at a maximum rate of ​15 percent​ in most cases. If your taxable income is less than ​$80,000,​ either a portion or all of your long-term capital gains may be nontaxable. Otherwise, short-term capital gains are taxed at your usual tax rate.