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1) I understand that buying a put is not a constructive sale as I only limit the loss but not the gain, right?

Unless the put is so deeply in the money that it is essentially the same as shorting the stock, you are correct.

2) Assume that the stock tanks in the next months so I get to exercise the stock and lock in my gain. I will pay short term cap gains on the stock, right?


Can I add the cost of the puts to the basis for my stock? Or how else can I take into account the fact that I paid something for the puts?

You subtract the cost of the puts from the selling price and report the net amount you recevied from the sale.

3) Assume the company does really well and the stock keeps going up. The puts just expire. If I sell the stock after a year after I originally bought it, is this going to be considered a long-term gain or short term because the holding period was reset to zero at the time when the put was bought or when the put expired?

It would be a short term gain because the holding period was reset when the option expired.

How do I take into account the price of the puts?

When an option position expires it is treated as if you closed the position (for zero dollars) on the day the option expired. Hence you would have a short-term loss equal to the amount you paid for the options.

If, at the end of the year, you still hold an offsetting position that has an unrecognized gain (in this case, if you still hold the stock and the stock is still above the price you paid for it) you can only claim the loss, if any, in excess of the unrecognized gain. If there is any loss you cannot claim in the year you recognized it, you must keep track of that loss and claim it in the year the ends without an offsetting loss.

For example, on March 1, 2000 you bought 100 shares of XYZ for $5,000. On October 1, 2000 you bought a put on XYZ for $500 which expired worthless on October 21, 2000. On December 29, 2000 (the last trading day of 2000) XYZ closes at $70/share. You show your $500/share loss on Form 6781. Because section 3 for the 6781 shows an unrecognized gain of $2,000 (which is greater than $500) you cannot claim any loss on you 2000 taxes. If you continue to hold XYZ through 2001 and on the last trading day of 2001 XYZ closes at $53/share, you would now fill out a second 6781 showing the $500 loss carried forward from the previous year, partially offet by the $300 unrecognized gain on stock. You would claim a $200 loss on your 2001 taxes and carry the remaining $300 into 2002. In 2002 you finally sell your XYZ stock. You could then claim the ramaining $300 loss on your 2002 taxes using your third Form 6781.

4) In general is it possible to add the cost of the put to the basis of the stock?

No, it is never possible to do so. If the option is exercised you will adjust the sale price, not the cost basis, of the stock. The impact is the same.

Or should it be claimed as a short term loss instead?

If the option position is closed for a loss, you will have a capital loss. It will be a short term loss if the holding period of the underlying stock was a year or less when you bought the option, otherwise it will be a long term loss.

When you can claim the loss depends on offsetting positions, as noted before.

For more information, see IRS publication 550

paying particular attention to the section on "straddles".

Note, I am not a tax professional. I do believe I have a good knowledge of the tax rules involved with your questions, but I cannot guarantee my interpretation of all aspects is correct.

Good Luck,
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