Cashless warrant exercise - tax consequences?

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psteinx
Posts: 2906
Joined: Tue Mar 13, 2007 2:24 pm

Cashless warrant exercise - tax consequences?

Post by psteinx » Wed Sep 26, 2018 1:24 pm

Example:

One has 100 warrants of ABC stock that one has owned for a while (long term).

The warrants have a basis of $20 each, and entitle the owner to buy ABC for $50/share. At exercise time, ABC is trading for $100/share, and the owner utilizes a cashless exercise provision, as provided for in the original documents, to cash in that (100 * ($100-$50=$50 in-the-money value)) to get ($5000/$50 = ) 50 shares of ABC.

Assume that the resulting ABC shares are not sold in the same tax year.

What are the tax consequences of that cashless exercise? Note that the warrants are not sold on the open market, nor are any shares - this is basically handled as an exchange between the warrantholder and ABC, along with various middlemen (brokerages, depository companies, etc.)

===

(Yes, this is a real issue for me. Various TARP warrants - some exercised, some whose exercise I'm contemplating... I think the example facts above capture the main points, though there may be complicating factors, and/or some differences between my example description and the actual situations.)

MotoTrojan
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Joined: Wed Feb 01, 2017 8:39 pm

Re: Cashless warrant exercise - tax consequences?

Post by MotoTrojan » Wed Sep 26, 2018 1:29 pm

psteinx wrote:
Wed Sep 26, 2018 1:24 pm
Example:

One has 100 warrants of ABC stock that one has owned for a while (long term).

The warrants have a basis of $20 each, and entitle the owner to buy ABC for $50/share. At exercise time, ABC is trading for $100/share, and the owner utilizes a cashless exercise provision, as provided for in the original documents, to cash in that (100 * ($100-$50=$50 in-the-money value)) to get ($5000/$50 = ) 50 shares of ABC.

Assume that the resulting ABC shares are not sold in the same tax year.

What are the tax consequences of that cashless exercise? Note that the warrants are not sold on the open market, nor are any shares - this is basically handled as an exchange between the warrantholder and ABC, along with various middlemen (brokerages, depository companies, etc.)

===

(Yes, this is a real issue for me. Various TARP warrants - some exercised, some whose exercise I'm contemplating... I think the example facts above capture the main points, though there may be complicating factors, and/or some differences between my example description and the actual situations.)
I consider myself highly knowledgeable with regards to various types of options and their tax consequences, but had never really heard of a warrant before. What is the meaning of the $20 basis? For example in incentive stock options the strike price ($50) would be your basis for future taxation upon sale, and with non-qualified options it would be the value at exercise ($100).

psteinx
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Joined: Tue Mar 13, 2007 2:24 pm

Re: Cashless warrant exercise - tax consequences?

Post by psteinx » Wed Sep 26, 2018 1:44 pm

I'm not sure if there's a real technical difference between a "warrant" and an "option", but my understanding is that in common parlance, warrants are longer term (years instead of months), and tend to be issued directly by the companies in question (yes, some "options" are, too...).

The warrants I'm concerned with were purchased, in the financial markets, pretty much the way shares of stock or whatever are. The basis is mostly the purchase price, but for some of the warrants I'm concerned with, there's, I think, some tweaking to that, based on some complexities not worth getting into here.

My real issue is, is the exercise of these warrants a taxable event or not? If it is taxable, is the relevant amount of taxation the total value by which the market price exceeds the strike, less basis, or is the taxation only applicable to the shares that were effectively sold to cover the cashless exercise? i.e. If 100 warrants were cashlessly exercised into 60* shares of common, is CG tax owed on the value that had been embedded in all 100 warrants, or only in the 40 that were "given up", to execute the cashless transaction. I guess in reality all 100 warrants are gone.

* Share amounts changed slightly from my original example, for clarity.

grok87
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Joined: Tue Feb 27, 2007 9:00 pm

Re: Cashless warrant exercise - tax consequences?

Post by grok87 » Fri Sep 28, 2018 7:18 am

psteinx wrote:
Wed Sep 26, 2018 1:44 pm
I'm not sure if there's a real technical difference between a "warrant" and an "option", but my understanding is that in common parlance, warrants are longer term (years instead of months), and tend to be issued directly by the companies in question (yes, some "options" are, too...).

The warrants I'm concerned with were purchased, in the financial markets, pretty much the way shares of stock or whatever are. The basis is mostly the purchase price, but for some of the warrants I'm concerned with, there's, I think, some tweaking to that, based on some complexities not worth getting into here.

My real issue is, is the exercise of these warrants a taxable event or not? If it is taxable, is the relevant amount of taxation the total value by which the market price exceeds the strike, less basis, or is the taxation only applicable to the shares that were effectively sold to cover the cashless exercise? i.e. If 100 warrants were cashlessly exercised into 60* shares of common, is CG tax owed on the value that had been embedded in all 100 warrants, or only in the 40 that were "given up", to execute the cashless transaction. I guess in reality all 100 warrants are gone.

* Share amounts changed slightly from my original example, for clarity.
I also would like to know.
Keep calm and Boglehead on. KCBO.

grok87
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Joined: Tue Feb 27, 2007 9:00 pm

Re: Cashless warrant exercise - tax consequences?

Post by grok87 » Mon Oct 01, 2018 3:54 pm

psteinx wrote:
Wed Sep 26, 2018 1:44 pm
I'm not sure if there's a real technical difference between a "warrant" and an "option", but my understanding is that in common parlance, warrants are longer term (years instead of months), and tend to be issued directly by the companies in question (yes, some "options" are, too...).

The warrants I'm concerned with were purchased, in the financial markets, pretty much the way shares of stock or whatever are. The basis is mostly the purchase price, but for some of the warrants I'm concerned with, there's, I think, some tweaking to that, based on some complexities not worth getting into here.

My real issue is, is the exercise of these warrants a taxable event or not? If it is taxable, is the relevant amount of taxation the total value by which the market price exceeds the strike, less basis, or is the taxation only applicable to the shares that were effectively sold to cover the cashless exercise? i.e. If 100 warrants were cashlessly exercised into 60* shares of common, is CG tax owed on the value that had been embedded in all 100 warrants, or only in the 40 that were "given up", to execute the cashless transaction. I guess in reality all 100 warrants are gone.

* Share amounts changed slightly from my original example, for clarity.
so i tried to exercise some of my tarp warrants. so far nothing has happened beyond a journal entry from my broker that they had received my instructions. i wonder if these are european style and can only be exercised on the expiration date?
Keep calm and Boglehead on. KCBO.

grok87
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Joined: Tue Feb 27, 2007 9:00 pm

Re: Cashless warrant exercise - tax consequences?

Post by grok87 » Fri Oct 05, 2018 7:33 am

update: the cash-less exercise of the warrants was successful.

then new shares are there and show what i was expecting. that my basis in the warrants carried over to the new shares and the unrealized gain is shown as long-term.

there was a cash-in-lieu payout for a fractional share. i did not buy a fractional number of warrants but somehow the fractional share was generated as part of the cashless exercise process. the cash-in-lieu payout is shown as being a short-term gain. this is somewhat annoying, albeit for small $, since the warrants were definitely held for a long term.
Keep calm and Boglehead on. KCBO.

psteinx
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Re: Cashless warrant exercise - tax consequences?

Post by psteinx » Wed Nov 07, 2018 3:56 pm

Bumping this - hopefully someone can offer some thoughts, information, and/or references on the tax implications...

grok87
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Re: Cashless warrant exercise - tax consequences?

Post by grok87 » Wed Nov 07, 2018 4:50 pm

psteinx wrote:
Wed Nov 07, 2018 3:56 pm
Bumping this - hopefully someone can offer some thoughts, information, and/or references on the tax implications...
So you read my post above right?
Assuming you have a gain,
Your capital gains remain deferrred, ie it carries over to the shares except for the cash you receive in lieu of fractional shares. That become short term capital gains which is a bit annoying.

If you have a loss i would maybe try to sell the warrants rather than exercise...
Keep calm and Boglehead on. KCBO.

psteinx
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Joined: Tue Mar 13, 2007 2:24 pm

Re: Cashless warrant exercise - tax consequences?

Post by psteinx » Wed Nov 07, 2018 5:19 pm

grok - I'm not entirely confident in what brokers may show, for this situation.

Do you have outside references for the tax treatment? (i.e. IRS publications, tax code references, or even information/articles from presumably reputable accountants...)

grok87
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Joined: Tue Feb 27, 2007 9:00 pm

Re: Cashless warrant exercise - tax consequences?

Post by grok87 » Wed Nov 07, 2018 5:26 pm

psteinx wrote:
Wed Nov 07, 2018 5:19 pm
grok - I'm not entirely confident in what brokers may show, for this situation.

Do you have outside references for the tax treatment? (i.e. IRS publications, tax code references, or even information/articles from presumably reputable accountants...)
Thanks psteinx.
No I don’t. Was just relying on the broker-fidelity.
Keep calm and Boglehead on. KCBO.

oslocal
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Joined: Sat May 21, 2016 5:30 pm

Re: Cashless warrant exercise - tax consequences?

Post by oslocal » Wed Nov 07, 2018 7:38 pm

psteinx wrote:
Wed Sep 26, 2018 1:24 pm
Example:

One has 100 warrants of ABC stock that one has owned for a while (long term).

The warrants have a basis of $20 each, and entitle the owner to buy ABC for $50/share. At exercise time, ABC is trading for $100/share, and the owner utilizes a cashless exercise provision, as provided for in the original documents, to cash in that (100 * ($100-$50=$50 in-the-money value)) to get ($5000/$50 = ) 50 shares of ABC.

Assume that the resulting ABC shares are not sold in the same tax year.

What are the tax consequences of that cashless exercise? Note that the warrants are not sold on the open market, nor are any shares - this is basically handled as an exchange between the warrantholder and ABC, along with various middlemen (brokerages, depository companies, etc.)

===

(Yes, this is a real issue for me. Various TARP warrants - some exercised, some whose exercise I'm contemplating... I think the example facts above capture the main points, though there may be complicating factors, and/or some differences between my example description and the actual situations.)
I would guess that the cashless exercise triggers the following:
the 50 warrants that were exercised and the shares held carry over the $20 basis plus the incremental $50 you would have to pay (i.e. new adj basis of $70)
the remaining 50 other warrants were essentially sold (or exercised and the shares sold), and you would have a $30 gain on those. (they are $50 in the money (the net proceeds) and you paid $20)

IRS rules on market options/warrants (as in not- qualifying ISO) are presumably structured so they cannot be sidestepped.

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