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Suppose that I sold a call option at $1/share on XYZ at a strike of $100.

The holder of the call exercised the option when the market price of XYZ is $110.

Now I need to buy 100 shares at $110 and sell them for $100.

So I made $100 of premium from writing the call but I lost $1000 from the shares.

Would the IRS count this as a $900 loss towards my short term capital gains

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Yes, this is a net short term capital loss deduction of $900.

FWIW, if you're going to chase short option premium, sell credit spreads so you can avoid large losses like this.

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