Six years ago, Linus Corporation granted Pauline a nonqualified option to purchase 5,000 shares of Linus stock for $13 per share. On date of grant, the market price was $11 per share. Last year, Pauline exercised the option when the market price was $47 per share. This year, she sold the stock for $40 per share. Compute Pauline's gain or loss recognized on sale.

Question

Quizplus · Accepted Answer

To compute Pauline's gain or loss, we need to calculate the cost basis of the shares she sold. The cost basis of the option shares is the sum of the exercise price ($13 per share) plus any amount of ordinary income recognized by Pauline when she exercised the option. Since this is a nonqualified option, the ordinary income is equal to the difference between the market price at exercise ($47 per share) and the exercise price ($13 per share), multiplied by the number of shares purchased (5,000 shares).

Therefore, the cost basis of Pauline's shares is ($13 + $34) * 5,000 = $235,000

The proceeds from the sale of the shares are the number of shares sold (5,000 shares) multiplied by the sale price ($40 per share), which is $200,000.

Therefore, Pauline's recognized loss is $235,000 - $200,000 = $35,000.

Six Years Ago, Linus Corporation Granted Pauline a Nonqualified Option