A stock warrant and a stock option are similar in that both instruments give you the right to buy stock at a specified exercise price. You may buy "investment" options and warrants in the open market from available sellers, and at a market-determined price. Your employer may grant you "compensatory" options or warrants in exchange for your services. The IRS treats the exercise of warrants and options that you acquire in either way in a similar manner.
When you hold a stock warrant or stock option, you have the right to exercise the instrument at any time. When you exercise, you acquire the stock that underlies the warrant or option; while warrants are exercised at the market price, the stock option specifies the price of the stock and the expiration date beyond which the option expires. In the case of investment options, you may also sell the option or warrant on the open market.
Capital Gains and Losses
If you sell an investment option or warrant, you may have a long- or short-term capital gain or loss. You calculate this by subtracting the cost basis of the purchase from the amount you received from the sale (broker and transaction fees figure into this calculation). The result is a long-term gain or loss if you held the instrument for longer than a year; a short-term gain if you held it for less than a year. The same applies if the warrant or option expires unexercised, which would result in a loss.
The IRS does not consider the exercise of a stock option or stock warrant as a taxable event. However, exercise means the acquisition of stock for calculating the eventual capital gain or loss on the stock when you sell it. The cost basis is the price you paid for the stock, with transaction fees added.
Sale of Stock
When you eventually sell the stock you acquired through exercise, you have a capital gain if you realized a profit, and a deductible loss if you took a loss. Even if you received the option or warrant as compensation, the stock is treated as investment property, not as employee compensation or income. The long-term and short-term loss definitions apply to stocks as well as options and warrants.
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