Using an Option to Defer Tax Consequences

In a typical option transaction, the option writer (seller) receives a sum of cash substantially less than the desired sales price that gives the option holder (buyer) the right to purchase the real estate at a set price at some time in the future.

The option holder may exercise the option and purchase the property during the option period.

Tax Effect

If Buyer Exercises  Option

Buyer Tax Effect

If the option is exercised, the amount paid for the option is capitalized (added to)  as part of the cost of the purchased property by the buyer when the option is exercised.

Seller Tax Effect

The option seller recognizes a capital gain on the sale of the option when the option is exercised (if the property on which the option was issued is capital gain property) [Reg. 1.1234-1(a)].

If Buyer Does not Exercise the Option

Buyer Tax Effect

The option holder(Buyer) recognizes a capital loss on the lapse of the option (if the property on which the option was issued is capital gain property) [Reg. 1.1234-1(a)].

  Seller Tax Effect

If the option is not exercised, the option writer (Seller) can keep the amount paid as consideration for granting the option but has no enforceable right of action against the option holder for damages. The option grantor recognizes ordinary gain on the lapse of the option [Reg. 1.1234-1(b)].