@MLP_Banana I can't find anything specific on whether an MLP should be a 1256 contract or not -- it definitely seems to be ambiguous right now -- but here's one article that discusses the topic (some forms of PTPs are definitely 1256, but MLPs aren't mentioned). I suspect that the broker is wrong on this, since an equity option (which 1256 doesn't cover) includes any option "That is valued directly or indirectly by reference to any stock or narrow-based security index." That would seem to apply to any option on a single MLP. https://www.forbes.com/sites/greatspeculations/2019/05/30/trading-futures-other-section-1256-contrac...
As to the tax code on valuing an exercised option, see Pub 550 and the discussion of "sale or trade" and "how to figure gain or loss". It formalizes the difference between your option leaving your account as worthless / unexercised (reported as a loss of the premium) and your option leaving your account because its being traded for something else of value. "Amount realized includes the money you receive plus the fair market value of any property or services you receive" https://www.irs.gov/pub/irs-pdf/p550.pdf
One final note: you can change the cost basis reported to the partnership at any time. They don't care, since you (the partner) are responsible for tracking your own cost basis. So if you wind up paying tax on the option as a 1256 contract, you can contact them to change the basis to $5.50 regardless of what the broker reports. If this gets treated as an equity option (not taxed), then you'd have the partnership change the basis to $3.50.
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**Note also, I'm not a Tax Preparer/CPA. Just a volunteer, seasoned, TurboTax user.
Use any advice accordingly!
