Covered Call Premiums and Taxes: Short-Term or Long-Term Capital Gains?

The Short Answer: Covered Call Premiums Are Almost Always Short-Term

When you sell a covered call and it expires worthless or you buy it back, the premium you collected is taxed as a short-term capital gain — no matter how long you have owned the underlying stock. That is the default rule under the U.S. tax code, and it catches a lot of traders off guard. The only time the story changes is when you get assigned, in which case the premium folds into the sale price of your shares and the gain on those shares can be long-term — but only if your holding period qualifies.

This article walks through exactly how the IRS treats each outcome: expiration, buyback, and assignment. It also covers the "qualified covered call" rules under IRS Section 1092, which can suspend your holding period if you sell a deep in-the-money call. Canadian investors will find a note on how the CRA handles things differently. Read this before your next earnings-cycle trade.

How the IRS Classifies Options Income: The Baseline Rules

The IRS treats options as capital assets. When you close or expire an option position, you recognize a capital gain or loss in the tax year the position closes. Because a single options contract almost never has a holding period longer than 12 months, the gain is nearly always short-term, taxed at ordinary income rates — which can be as high as 37% for high earners in 2024.

FINRA and the Options Industry Council (OIC) both note that options income does not qualify for the preferential 0%, 15%, or 20% long-term capital gains rates unless the underlying shares themselves are sold at a long-term gain after assignment. The premium itself never ages into a long-term gain just because you hold the call open for a long time — the holding period clock on the option resets with every new contract you sell.

One more baseline point: the premium you collect is not income when you receive it. It sits in your account as an open short position. You only recognize the gain or loss when the position is closed — by expiration, buyback, or assignment. This is called "open transaction" treatment, and it is standard for short options under U.S. tax rules.

Three Outcomes, Three Tax Treatments

**Outcome 1 — The call expires worthless.** You keep the full premium. On expiration day, the IRS treats this as a short-term capital gain equal to the premium received. Example: You own 100 shares of AAPL, currently at $195. You sell one $200-strike call expiring in 30 days and collect $2.10 per share, or $210 total. The call expires worthless. You report a $210 short-term capital gain. Your AAPL holding period is unaffected — you still own the shares.

**Outcome 2 — You buy the call back before expiration.** Your gain or loss equals the premium received minus the buyback cost. If you sold that same AAPL $200 call for $2.10 and bought it back for $0.80, your short-term gain is $1.30 per share, or $130. Again, short-term regardless of how long the position was open.

**Outcome 3 — You get assigned.** This is where long-term treatment becomes possible. When your shares are called away, the IRS adds the premium you collected to the sale proceeds of the stock. So if you paid $170 for AAPL, sold the $200 call for $2.10, and got assigned at $200, your effective sale price is $202.10. Your total gain is $32.10 per share. If you held those AAPL shares for more than 12 months before assignment, that entire $32.10 gain — including the premium — is taxed at the long-term capital gains rate. The premium does not get split out and taxed separately.

The Qualified Covered Call Rule: When Selling a Call Can Hurt Your Holding Period

Here is the risk most retail traders do not know about. Under IRS Section 1092, if you sell a covered call that is "not a qualified covered call," the IRS suspends your holding period on the underlying shares for as long as that call is open. If the suspension pushes you below the 12-month threshold, a gain that would have been long-term becomes short-term.

A call is a qualified covered call if it meets specific strike-price and term tests set out in the tax code. In plain English: the call must not be too deep in the money. The IRS uses a tiered table based on the stock price to define how far in the money is too far. For stocks trading above $25, a call is generally qualified if the strike is at or above the first available strike below the stock's closing price on the day you sell. Calls with more than 33 months to expiration face additional restrictions.

Practical example: You bought 100 shares of MSFT at $380 eight months ago. MSFT is now at $415. You sell a $390-strike call — that is $25 in the money. If this call fails the qualified covered call test, your eight-month holding period is frozen until you close the call. If you then sell the shares within four months of closing the call, you may not reach 12 months and your gain is short-term. Selling at-the-money or out-of-the-money calls almost always avoids this problem. When in doubt, use tax software that tracks Section 1092 or ask a tax professional before selling deep in-the-money calls on shares you are close to the 12-month mark on.

A Full Worked Example: NVDA Covered Call, All Three Scenarios

Assume you bought 100 shares of NVDA at $600 on January 15, 2024. By July 15, 2024 — exactly six months later — NVDA is trading at $1,200. You sell one $1,250-strike call expiring August 16, 2024, and collect $18.00 per share ($1,800 total). The call is out of the money, so it is a qualified covered call and your holding period keeps running.

**Scenario A — Expires worthless (August 16):** NVDA closes at $1,210. You keep $1,800. That $1,800 is a short-term capital gain reported on your 2024 taxes. Your NVDA shares now have a seven-month holding period. You still need five more months to reach long-term status.

**Scenario B — You buy it back (August 1):** NVDA drops to $1,150. The call is worth $4.00. You buy it back for $400, locking in a $1,400 short-term gain ($1,800 minus $400). Same tax treatment as Scenario A.

**Scenario C — Assigned (August 16):** NVDA surges to $1,300. Your shares are called away at $1,250. Your effective sale price is $1,250 + $18 = $1,268 per share. Your gain is $1,268 minus $600 = $668 per share, or $66,800 total. Because you have only held NVDA for seven months at assignment, this entire gain — including the $1,800 premium — is a short-term capital gain. Had you waited until after January 15, 2025 to sell the call and been assigned, the gain would have been long-term. Timing matters enormously.

What Canadian Investors Need to Know (CRA Rules)

The Canada Revenue Agency treats covered call premiums differently from the IRS. Under CRA guidance, the premium you receive when you write a covered call is generally treated as a capital gain in the year the option expires or is closed — not as income. However, if the CRA determines you are trading options as a business (frequent trading, short holding periods, intent to profit from price movements), the premiums can be reclassified as fully taxable business income rather than capital gains.

For Canadian investors who hold shares long-term and sell occasional covered calls, the premium is typically 50% included in income as a capital gain — the same inclusion rate as other capital gains. If the call is exercised and your shares are sold, the premium is added to the proceeds of disposition, just as the IRS does. The key CRA risk is the business-income reclassification, which eliminates the 50% inclusion advantage. If you are selling covered calls frequently or on a large scale, speak with a Canadian tax advisor before year-end.

Practical Steps to Manage Your Tax Exposure

First, track your holding period on every lot before you sell a call. If you are within 12 months of purchase on shares with a large unrealized gain, selling a deep in-the-money call could cost you significantly more in taxes if you get assigned. Most brokerage platforms show your cost basis and purchase date — check it before placing the order.

Second, stick to at-the-money or out-of-the-money strikes when you want to protect a long-term holding period. These calls almost always qualify under the Section 1092 rules, so your holding period keeps running while the call is open.

Third, consider the after-tax premium. A $3.00 premium on a short-term gain taxed at 37% leaves you $1.89. The same $3.00 premium collected after you cross the 12-month mark and get assigned at a long-term rate of 15% leaves you $2.55. The difference is real money.

Fourth, keep records. The IRS and FINRA both require accurate reporting of options transactions. Your broker will issue a Form 1099-B, but it does not always correctly apply Section 1092 adjustments. Use tax software designed for options traders or work with a CPA who understands derivatives. The OIC offers free educational resources on options taxation that are worth reviewing before filing.

Are covered call premiums taxed as ordinary income or capital gains?

Covered call premiums are taxed as short-term capital gains, not ordinary income, when the option expires or is bought back. Short-term capital gains rates are the same as ordinary income rates, so the practical difference is small — but the classification matters for certain deductions and state tax rules. If you are assigned and your shares are sold at a long-term gain, the premium folds into that long-term gain.

Does selling a covered call reset my long-term holding period on the stock?

It can, but only if the call fails the IRS qualified covered call test under Section 1092. Selling an at-the-money or out-of-the-money call generally does not affect your holding period. Selling a deep in-the-money call on shares you have held for less than 12 months can suspend your holding period clock for as long as the call is open, potentially turning a future long-term gain into a short-term one.

What happens to the premium if my covered call gets assigned?

When your shares are called away, the IRS adds the premium you collected to your sale proceeds. So if your strike is $200 and you collected $2.00 in premium, your effective sale price is $202 per share. The gain on the entire position — including the premium — is then long-term or short-term depending on how long you held the underlying shares.

Can I use covered call losses to offset long-term capital gains?

Yes, but the loss will be short-term. If you sold a covered call for $3.00 and bought it back for $5.00, you have a $2.00 short-term capital loss per share. Under IRS rules, short-term losses first offset short-term gains, and any excess can offset long-term gains. This can still reduce your overall tax bill, just not at the preferential long-term rate.

How does Canada's CRA tax covered call premiums differently from the IRS?

The CRA generally treats covered call premiums as capital gains, meaning only 50% of the gain is included in taxable income for most investors. The IRS treats the same premium as a fully taxable short-term capital gain. The CRA risk is reclassification as business income if you trade frequently, which eliminates the 50% inclusion benefit — so Canadian investors who write calls regularly should get advice from a Canadian tax professional.

Do I owe taxes on a covered call premium the year I receive it or the year it closes?

You owe taxes in the year the position closes, not the year you receive the cash. The IRS uses "open transaction" treatment for short options, meaning the premium sits as an open liability until the call expires, is bought back, or results in assignment. This means a call you sell in December 2024 that expires in January 2025 is reported on your 2025 tax return, not your 2024 return.