Consider a more extreme example: an MLP is trading for $1000/share. You spend $999 to buy an option with a $1 strike price, and immediately exercise it. Your argument is that you should report a $999 loss to the IRS (the premium lost), and carry the MLP share on your books at a $1 cost basis. That's not how this works.
So going to your example:
- If this was a regular equity option, you'd exercise at $2.50, add the cost of the premium to your basis, and carry it on your books at $3.50. There'd be no taxable event this year, and you'd have a $2 unrecognized gain which would be taxed when you eventually sold.
- Because this is being treated as a 1256 contract, you're paying tax on the $2 now. But that also means you have to record a cost basis of $5.50 so you don't have any additional tax owed if you were to sell tomorrow. If your broker refuses to report the acquisition at market price, you'll have to maintain your own records.
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**Note also, I'm not a Tax Preparer/CPA. Just a volunteer, seasoned, TurboTax user.
Use any advice accordingly!
