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I recently started selling covered calls and was curious how USA taxes for premium collected on unassigned covered calls worked. I was under the impression that such premiums will classify as short-term gains but this link (https://www.streetauthority.com/16452/use-this-strategy-to-save-thousands-on-your-taxes/) says that we can use it to lower cost basis and defer the tax on premium to the time when we actually sell the underlying shares. Can someone shed some light on this?

I tried searching more on this over past few days and haven't come across any IRS provision like this. I know the broker's platform doesn't change the actual cost basis of the underlying so seems like even if this was possible I would need to somehow manually track this. Any insights are appreciated.

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The opinion expressed by Street Authority is utterly wrong.

From IRS Publication 550, page 57:

Writer of option. If you write (grant) an option, how you report your gain or loss depends on whether it was exercised.

If you are not in the business of writing options and an option you write on stocks, securities, commodities, or commodity futures is not exercised (or repurchased), the amount you receive is a short-term capital gain.

From page 58:

Writers of puts and calls

When a call is exercised: Increase your amount realized on sale of the stock by the amount you received for the call.

When a call expires: Report the amount you received for the call as a short-term capital gain.

If you buy back the call, report the difference between the amount you pay and the amount you received for the call as a short-term capital gain or loss.

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  • This was my understanding too. However, I have seen this "cost basis reduction" one other place (reddit I think) so will research this a bit more. I am 99% sure your answer is right. Will mark it correct in due course of time. +1 – Shree Dec 4 '20 at 15:57
  • On one hand there's the above citation from IRS Publication 550 and on the other hand there's what you might have read on Reddit. Hmmm, which one is correct? LOL. FWIW, be careful about what you read on Reddit. There's an awful lot of bad info there. – Bob Baerker Dec 4 '20 at 16:43
  • As mentioned in my question, I am aware IRS doesn't seem to provide such "cost-basis reduction" provision. I literally said this answer is most likely right so not even comparing it with the streetauthority article or reddit. Just that there's no harm in trying to find more info. If I took such articles or reddit posts on face value I wouldn't even be asking this question here. – Shree Dec 4 '20 at 18:56

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