Rev. Rul. 70-205

Advice has been requested as to the income tax consequences of the transaction described below.

The taxpayer purchased 1,000 shares of stock for $67,000 and simultaneously sold a 30-day call option on these shares for $10,000. Prior to the expiration of the 30-day option period, the taxpayer repurchased the call option for $16,000 and simultaneously sold the 1,000 shares of stock for $74,000. The taxpayer is neither a stockbroker nor a dealer in securities and the purchases and sales were transacted through his stockbroker. The specific question relates to the treatment of the loss resulting from the sale and repurchase of the call option.

Section 1234(a) of the Internal Revenue Code of 1954 provides that "gain or loss attributable to the sale or exchange of, or loss attributable to failure to exercise, a privilege or option to buy or sell property shall be considered gain or loss from the sale or exchange of property which has the same character as the property to which the option or privilege relates has in the hands of the taxpayer (or would have in the hands of the taxpayer if acquired by him)."

Section 1.1234-1(a) of the Income Tax Regulations provides, in part, that under certain circumstances a gain or loss from the sale of an option to buy or sell property that is a capital asset in the hands of the taxpayer holding the option is considered as gain or loss from the sale or exchange of a capital asset. Under the provisions of section 1.1234-1(b) of the regulations any gain to the grantor of an option arising from the failure of the holder to exercise it is ordinary income.

Revenue Ruling 58-234, C.B. 1958-1, 279, holds that if a "put" option or "call" option is exercised, the premium (consideration paid for the option) is allocated as an adjustment to the price or cost of the underlying stock that is the subject of the option, so that capital gain may result. That Revenue Ruling recognizes that the optionor, seeking to minimize or conclude the eventual burden of his option obligation, might pay the optionee, as consideration for cancellation of the option, an amount equal to or greater than the premium. No income, gain, profits, or earnings are derived from the receipt of either a "put" or "call" option premium until the option expires without being exercised, or is terminated upon payment by the optionor of an amount less than the premium.

In the instant case, it is held that the amount paid by the taxpayer to repurchase the call option in excess of the selling price received for the call option is a capital expenditure that is additional cost of the underlying corporate stock to be taken in account in determining gain or loss on the sale of such stock.

The following represents the proper method of treating the gain resulting from the sale of stock and the loss resulting from the repurchase of the call option in the instant case:

 Sales price of stock _________________________  $74,000