How Taxation is Applied When Using the PMCC Strategy
When executing a Poor Man’s Covered Call (PMCC), taxation is applied based on the following components:
- LEAPS (Long-term Equity Anticipation Securities): If held for over a year, gains qualify for long-term capital gains tax rates. Otherwise, they are taxed as short-term gains.
- Short Call Premiums: The premiums received from selling short calls are taxed as short-term capital gains in the year received.
- Assignment or Sale of LEAPS: If assigned or sold before one year, any gains are considered short-term. If held for more than one year, they qualify for long-term capital gains rates.
What Happens if the Buy Amount is Greater Than the Realized Sells?
If your cost of purchasing new LEAPS exceeds the proceeds from selling short calls and closing previous LEAPS positions, the following tax consequences arise:
- Taxable Income from Short Calls: Even if you reinvest short-call proceeds into new LEAPS, the premiums received are taxable in the year earned.
- Capital Gains or Losses on LEAPS: If you sell a LEAPS contract at a gain or loss, it is taxed based on your holding period.
- Wash Sale Rule Consideration: If you sell LEAPS at a loss and immediately buy another similar LEAPS, the loss may be disallowed under the wash sale rule.
Holding Period of LEAPS
If LEAPS are held for over a year before selling, any gains qualify for long-term capital gains tax rates, which are lower than short-term capital gains rates. This strategy helps in minimizing tax liability.
What Happens if You Keep Buying LEAPS Using Your Sell Gains?
Continuously buying new LEAPS using the gains from selling old LEAPS and short calls does not defer taxes. Key tax implications include:
- Gains from short call sales are taxable in the year received.
- LEAPS sales are taxed based on holding period (short-term or long-term).
- Reinvesting does not reduce taxable income, as each sale is a separate taxable event.