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From what I understand, if I exercise in-the-money ISOs, I'll be taxed on the supposed gains, even if the stock isn't tradeable (because, for example, it's stock in a privately-held company). Does the converse apply? That is, if I exercise underwater ISOs, can I claim a loss?

Let's say as an example that the current valuation is $1/share, but the options are priced at $2/share.

  • Can you expand your question to include numbers to help clarify what you mean? – JTP - Apologise to Monica Jun 21 '13 at 21:11
  • Sure thing, one moment. – Carl Norum Jun 21 '13 at 21:12
  • Your premise is wrong. There is no tax on exercising an ISO. That's specifically the tax advantage of ISOs. – David Schwartz Mar 20 '17 at 2:51
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No, because you didn't lose anything. When you exercise ISO "at loss" you're buying stock without a discount, that's it.

  • Does that mean it's asymmetric? I mean, if I exercise the in-the-money option, I'm taxed because I gained an asset worth more than I paid for it. In this case, I'd be paying for an asset worth less than I paid for it. If the company were public, it would just be crazy - I'd be better off buying shares at market price. Buying shares of the private company (outside of options exercising) just isn't possible. – Carl Norum Jun 21 '13 at 21:03
  • @Carl I don't follow you. Why would you pay more than what the stock is worth? In any case - whatever you paid is your basis in the stock. The tax is on the discount, which you didn't get if you bought at a loss, so nothing to tax. – littleadv Jun 21 '13 at 21:34
  • As I mentioned in my comment on @JoeTaxpayer's answer, it's stock in a privately-held company, and there's no other way to buy it. If I quit, for example, I'd be forced to exercise my options within 90 days or abandon them. I'm just wondering if there's any tax advantage to be gained from doing so or not. It sounds like "not" - the taxation being on the discount makes sense - I guess I wasn't thinking of it that way. In this case I'd have a "negative discount" so to speak, but I can see how that wouldn't count as a loss. – Carl Norum Jun 21 '13 at 21:38
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If you do this, you own a stock worth $1, with a basis of $2. The loss doesn't get realized until the shares are sold. Of course, we hope you see the stock increase above that price, else, why do this?

  • They're options in a private company. I have no other way to obtain shares in the company outside of such an option exercise. If I were to quit, for example, I'd have to exercise the options within 90 days or abandon them. The in-the-money ISOs are taxed (sort of - just AMT, right?) at exercise time, I just want to know if it's symmetric for an underwater option. – Carl Norum Jun 21 '13 at 21:18
  • Understood. Non public shares, you feel are worth a premium to gain ownership. I think the people that did this for google shares are pretty happy. – JTP - Apologise to Monica Jun 21 '13 at 21:20
  • Also keep the investment reasonable and conservative. Most startups are not google. – Paul Jun 23 '13 at 6:26

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