LEAPS options are taxed as capital gains or losses when you close them, with the rate depending on how long you held the contract, except for LEAPS on broad-based indexes, which fall under Section 1256 and receive automatic 60/40 treatment regardless of holding period. Exercising a LEAPS rather than selling it changes the picture again, and a handful of trap rules — wash sales, constructive sales, and a restarted holding period on exercised calls — can turn a well-planned trade into an unexpected tax bill. The rules below apply to Long-Term Equity Anticipation Securities, the exchange-traded options contracts that carry expirations of roughly one to three years.
A Short Primer Before the Tax Rules
LEAPS use the same 100-share contract size and the same call-and-put structure as any other listed option. What sets them apart is time: equity LEAPS expire in January each year, with new series typically listed about three years before expiration, and index LEAPS are also available with January, June, and December expirations. They’re American-style, so they can be exercised on any business day before expiration.1OCC. Equity Options Product Specifications Most holders never exercise. They sell the contract on the open market to capture the change in premium, or they let it expire worthless. Because those choices produce different tax outcomes, it’s worth walking through them separately.
Selling a LEAPS to Close the Trade
The most common taxable event with LEAPS is selling the contract itself, not exercising it. When you sell to close, the difference between your sale proceeds and the premium you originally paid is a capital gain or loss. The rate depends entirely on how long you held the contract before selling.
Hold the LEAPS for more than 12 months and the gain qualifies as long-term. The federal long-term capital gains rate tops out at 20% for high earners, compared with ordinary income rates that can reach 37%. Most filers pay 15%.2Office of the Law Revision Counsel. 26 USC Title 26 Subtitle A Hold the contract for 12 months or less and the gain is short-term, taxed at your ordinary income rate.
Because LEAPS routinely live past that one-year mark, the long-term rate is often within reach — one of the quiet tax advantages of trading them over shorter-dated options. Watch the calendar carefully. Selling a day short of the one-year threshold can push a gain from 15% to whatever your marginal ordinary rate happens to be.
The 3.8% Net Investment Income Tax
Higher-income investors face an additional layer. The Net Investment Income Tax applies a 3.8% surtax to capital gains, including options gains, once your modified adjusted gross income exceeds $200,000 for single filers or $250,000 for married couples filing jointly.3Internal Revenue Service. Net Investment Income Tax Stacked on the 20% long-term rate, the effective maximum federal tax on a long-term LEAPS gain reaches 23.8%. Forgetting about the NIIT is one of the more common planning mistakes with options.
Index LEAPS and Section 1256
LEAPS on individual stocks and ETFs follow the holding-period rules above. LEAPS on broad-based market indexes do not. These qualify as nonequity options under Section 1256 of the tax code and receive automatic 60/40 treatment: 60% of any gain is taxed at the long-term capital gains rate and 40% at the short-term rate, no matter how long you held the position.4Office of the Law Revision Counsel. 26 USC 1256 – Section 1256 Contracts Marked to Market
The distinction between equity and nonequity options is where people slip. Options on SPY, the ETF that tracks the S&P 500, are equity options. Fund shares are treated as stock, so options on them are treated as options on stock. Options on the SPX index itself are nonequity options and qualify for the 60/40 benefit. Section 1256 defines equity options as those on stock or narrow-based security indexes, so options on broad-based indexes such as the S&P 500, Nasdaq-100, or Russell 2000 fall outside that definition and get the preferential treatment.4Office of the Law Revision Counsel. 26 USC 1256 – Section 1256 Contracts Marked to Market
Year-End Mark-to-Market
Section 1256 contracts carry a mark-to-market requirement that catches new traders by surprise. If you hold an index LEAPS on December 31, the IRS treats it as if you sold it at fair market value on the last business day of the year. You report the resulting gain or loss on that year’s return even though you still own the contract. When you eventually close the position, your cost basis is adjusted for gains or losses already reported.4Office of the Law Revision Counsel. 26 USC 1256 – Section 1256 Contracts Marked to Market So a two-year index LEAPS that you open in March and close 18 months later will produce a tax event at the December 31 in between, not just at the closing sale.
Exercising a LEAPS Call
Exercising creates a different set of tax consequences from selling, and the key surprise is what happens to the holding period on the shares you acquire. Exercise itself is not a taxable event. The premium you paid for the call is added to the stock’s cost basis. Pay $12 per share for a call with a $100 strike and your cost basis in the stock is $112. Tax is owed later, when you sell the stock.
Here is the catch. The holding period on the stock starts fresh on the exercise date. The time you held the LEAPS contract does not count toward the stock’s holding period.5Office of the Law Revision Counsel. 26 USC 1223 – Holding Period of Property So if you held a LEAPS call for 18 months, then exercised and immediately sold the stock, the stock sale produces a short-term gain taxed at ordinary income rates, because you held the stock for zero days. You’d need to hold the acquired shares for more than a year after exercise to get long-term treatment.
For many investors who plan to convert a profitable long-held LEAPS into a stock position, the better move is to sell the LEAPS itself, capturing the long-term gain on the option, and then buy the stock separately in a fresh transaction. You end up in roughly the same economic position with a much better tax outcome.
Exercising a LEAPS Put
Exercising a LEAPS put means selling stock at the strike price. The premium you paid for the put reduces your proceeds. If the strike is $100 and you paid $8 per share for the put, your effective sale proceeds are $92 per share. Whether the resulting gain or loss is long-term or short-term depends on how long you held the underlying stock, not how long you held the put.
The interaction between put holding periods and stock holding periods can create complications under the short sale rules of Section 1233, particularly when you acquired the stock and the put around the same time. Getting professional advice before exercising a LEAPS put on stock with a short holding period is worth the cost.
Wash Sales Apply to LEAPS
The wash sale rule disallows a capital loss if you buy substantially identical securities within 30 days before or after selling at a loss. The IRS states explicitly that wash sale rules apply to options on stock, not just to stock itself.6Internal Revenue Service. Publication 550 (2025) – Investment Income and Expenses
Whether a LEAPS call on a given stock counts as substantially identical to that stock is decided under a facts-and-circumstances test rather than a bright-line rule. Publication 550 provides guidance on when convertible securities are substantially identical to the underlying, looking at factors like price correlation and conversion terms. The IRS has not published a definitive ruling saying all deep-in-the-money calls are substantially identical to stock, but the closer a call’s delta sits to 1.0, the more it behaves like the stock and the riskier the position becomes for wash sale purposes.
Practical rule: if you sell a stock at a loss and buy a LEAPS call on the same stock within the 30-day window, assume the loss may be disallowed. A disallowed loss isn’t lost permanently. It gets added to the cost basis of the replacement position, which recovers the deduction when that position is eventually closed. But the timing of the deduction can shift by years, which matters if you were counting on the loss to offset gains in the current year.
The Constructive Sale Trap on Protective Puts
Buying a deep-in-the-money LEAPS put against stock you already own with unrealized gains can trigger a constructive sale under Section 1259. A constructive sale forces you to recognize the gain on your stock position as if you had sold it, even though you still hold the shares.7Office of the Law Revision Counsel. 26 USC 1259 – Constructive Sales Treatment for Appreciated Financial Positions
The statute targets transactions that eliminate substantially all of the risk and reward of owning a position. A short sale of the same stock is the textbook trigger, but the law also covers one or more other transactions that have substantially the same effect. A deep put that essentially locks in your selling price while you simultaneously hold the stock can cross that line. An at-the-money or out-of-the-money protective put generally does not trigger a constructive sale, because you retain meaningful downside risk below the strike price. The distinction is worth taking seriously before buying long-dated protection on a highly appreciated holding.
Early Assignment on Written LEAPS
One more wrinkle for sellers rather than buyers. If you’ve written LEAPS, early assignment is a real possibility around ex-dividend dates. When a dividend-paying stock is about to go ex-dividend and the call you sold is in the money, the call holder has an incentive to exercise early if the dividend exceeds the remaining time value in the option. Over a two- or three-year contract, that risk repeats every quarter. Assignment forces the sale of shares, which is a taxable event on your side of the trade, and the timing can land in a year you didn’t plan for.
Putting the Rules Together
The tax picture on LEAPS comes down to a few decisions made before you place the trade. Are you buying an equity LEAPS or an index LEAPS? The index version is a Section 1256 contract with 60/40 treatment and year-end mark-to-market. Do you plan to sell the contract or exercise it? Selling a long-held LEAPS captures the long-term rate; exercising restarts the holding period on the stock. Are you sitting on a loss you want to harvest? Buying a LEAPS call on the same name within 30 days risks a wash sale. Are you protecting a big unrealized gain with a put? A deep-in-the-money strike can trigger a constructive sale. And once your MAGI clears the $200,000 or $250,000 threshold, add 3.8% to whatever rate you thought applied.