29th Sep, 2008

Equity Options TAX Treatments

Equity Options USA (877) 777-4727

We are not offering tax advice. You must seek advice from an independent tax advisor and your circumstances are unique to you. 

The tax treatment of options and forward sales contracts is well established in tax code, revenue rulings and case law. You will find a very favorable environment exists for these “types” of agreements. 

See one comment that was blogged by MG:

To answer the IRS question, if it acts like other types of options, the true value is not realized until the position is closed, and that’s when taxing takes place. I’m not an accountant or lawyer but that’s how the other options I deal with work. Seek tax and legal advice before trusting my description.

Example:
I buy a house today for $300,000 cash and immediately sell an “option” (Rex agreement) on 1/3 the future value of my house for $100,000 cash (open the option position). 15 years from today, I sell my house for $600,000, of which, I get to keep $400,000 (2/3 value and $100,000 profit), and Rex gets $200,000, (1/3 value and $100,000 profit).

Me
Today
-300,000 buy house
+100,000 sell option
Future
+600,000 sell house
-200,000 Buy option
net 200,000 gain

Rex
Today
-100,000 sell option
Future
+200,000 sell option
net 100,000 gain

This is where it gets interesting, technically the option is never exercised because Rex never actually takes possession of the underlying instrument. In other words, all Rex is doing is buying an option on 1/3 value for $100,000 and then selling the option back to the “owner” at closing for $200,000. The $300,000 profit made on the house may be taxable to the “owner” as capital gains, even though the “owner” only gets to keep $100,000 of that profit because he must buy back the option. That said, they may be able to write off the $100,000 of capitol loss on the option to Rex. This is where a tax accountant or tax lawyer is needed to hash out the details.

Usually, options are looked at as a completely separate instrument from the underlying instrument, so the profit made on the sale of the house is completely separate from the profit made on the sale of the option. In the example, the option is sold for $100,000 today and bought back for $200,000 when the house is sold. The house is bought for $300,000 today and sold for $600,000 15 years later. That means for the owner, there is a $300,000 capital gain on the house being offset with a $100,000 capitol loss on the option.

I’m really curious how a tax accountant or lawyer would see this and what the current law is. Keep in mind, If there is a tax benefit to this type of program, the law could change during the agreement and wipe out any and all tax benefits with no recourse for the owner. Posted by MG | February 26, 2008 11:11 PM 

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