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Date:   Sat, 10 Oct 2009
From:   Joseph

If I exercise options by using old and cold shares under Internal Revenue Code Section 1036 (a swap), do I recognize tax preference on only the new shares I receive instead of all the option shares? If not, which shares have the additional AMT basis?

Joseph

Answer

Date:   12 Oct 2009

Hello Joseph,

An equal number of shares to the number of shares surrendered keep the same tax basis and holding period. For regular tax purposes, any additional shares received that were paid for using the previously exercised shares have a tax basis of zero and the holding period starting on the date of exercise. If shares are sold before the holding period requirements are met, the shares for which ordinary income would be recognized are considered sold first. (Treasury Regulations § 1.422-5(b)(2).)

For alternative minimum tax reporting, the rules are similar to those for non-qualified options. An equal number of shares received to the number surrendered will receive the tax basis and holding period of the previously held shares. The fair market value of any additional shares received that were paid for using the previously held shares is reported as an AMT adjustment for exercise of the incentive stock options. The ordinary income reported for AMT will equal the excess of the fair market value over the option price of all of the ISOs that were exercised. (Internal Revenue Code § 56(b)(3), Revenue Ruling 80-244.)

Good luck!

Mike Gray

For more information about incentive stock options, request our free report, Incentive Stock Options - Executive Tax and Financial Planning Strategies.

IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this answer was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.