I think I understand everything in the explanation except at the bottom of the second paragraph:
“The shares were sold for $105 per share, but the cost of the put premium ($5) is subtracted, resulting in sales proceeds of $135 per share.”
Where does the $105 number come from? I thought the shares were sold at $140.
So if the investor had waited until after Feb 13, 2021 to purchase the put, then the investor would have had a long-term capital gain if stock is sold on the Feb 28 date?
Another question: What would have happened had the investor sold the put on the day of expiration and collected short term capital gains on the put contract, then turned around and sold the shares at the market price later that day? Would that have freed his shares from the short term capital gain classification, so he could get the lower, long-term tax rate? Or does the freeze placed on the holding period make the investor have to continue holding the shares for the amount of time that the put option was held?
Then, finally, one last question: I sometimes open put credit spreads with 45 days to expiration. If I were also long stock during this time, does the put credit spread create a freeze on the holding period for the long stock position?
You’re right - while the math is right, it looks like there is a typo in the explanation. It should be $140 - $5 = $135. I’ve just corrected this.
Yes, because the shares would have been held for at least a year-and-a-day at that point. Once it has reached long-term treatment, it stays there.
I believe that the holding period would basically be reset and start over with the purchase of the put. Here’s a related reference from Fidelity.
A “protective put” implies that stock was purchased previously and that puts are being purchased against an existing stock position, and protective puts can affect the holding period of the stock for tax purposes. If a stock is owned for less than one year when a protective put is purchased, then the holding period of the stock starts over for tax purposes. However, if a stock is owned for more than one year when a protective put is purchased, then the gain or loss on the stock is considered long-term regardless of whether the put is exercised, sold at a profit or loss or expires worthless.
@brandonrith can you confirm that the holding period resets?
I believe it would be reset in this case as well, assuming that your long stock has been held a year or less. Another one for @brandonrith to double-check
Great summary, @Justin. Buying a protective put on any day other than the day the stock was purchased while the shares are short term will automatically reset the holding period on the stock to zero. The holding period stays at zero until the put expires or is closed out. If this occurs, the holding period on the stock begins counting again. It will always occur this way unless the stock is already long term at the time the put is purchased. In this scenario, the holding period remains long term regardless of the protective put.
For @Gray’s second question - I’m not aware of any “workaround” when it comes to the resetting holding period situation with long stock and a long put. I understand a credit spread is a different strategy, but I don’t believe the IRS would necessarily segregate those positions. Essentially, they’re looking to identify these two things:
Is the long stock position currently short term?
Was there a put purchased on the underlying stock on any day other than the day the stock was purchased?
If the answer to both questions is yes, then the holding period on the stock should go to zero and stay there until the put expires or is closed out. Shouldn’t matter if the long put was part of a put spread to the best of my knowledge.
FYI - the second question should not be testable on the Series 7. Still, great question!
