Did you vest another batch of ISOs in 2025 and you are not sure when to use them? The best practice is to exercise ISOs in the first quarter of the year. You will be in a strong position with your share ownership when you do so. Here are the reasons:
- Meet the ISO holding requirement
- Can sell shares to pay AMT
- Flexibility if share price drops
ISO Holding Requirement
Remember that ISOs need to be held for at least one year after exercise to get the long term capital gains tax benefit. When you exercise your ISOs in Q1 26 you have to wait until Q1 27 to sell the shares to get the tax perk. You can hold onto the shares for a much longer period if you like and still get the tax advantage.
For example, you exercise your ISOs on January 14, 2026 and wait until January 15, 2027 to sell the shares. You get the ISO tax perk and pay long term capital gains.
Your long term capital gains tax rate is much lower than your short term capital gains rate. So you will save a lot of money on taxes!
Sell Shares to Pay AMT
After meeting the ISO holding requirements, you may have to pay AMT. In our example, let’s presume that you must pay the AMT. It will be due on April 15, 2027.
If you don’t have enough cash on hand to pay the taxes, you can sell some of your shares (from the January 14, 2026 exercise) to pay the AMT. Here’s our example timeline:
- January 14, 2026 – Exercise ISOs
- January 15, 2027 – Sell shares
- January 16, 2027 to April 15, 2027 – Pay the AMT
Flexibility on Share Price
Continuing with another scenario in our example, the share price drops 20% throughout 2026. You decide to sell the shares before December 31, 2026 and claim a loss on them.
When you do this, the ISO becomes an NSO because you didn’t meet the holding period requirement (1 year from exercise to sale). But this doesn’t matter. You don’t owe capital gains taxes because you haven’t made money on the shares.
Also, you cancel out the AMT on these shares because they are now NSOs. Although you may have lost 20% on the shares, you can use it as a tax benefit for tax loss harvesting. Offset the gains on some of your winning investments.
When Not to Exercise ISOs
It’s dangerous to exercise ISOs at the end of the year. You don’t get a full calendar year to understand your tax picture. Also, you only have a few weeks to make a decision on the share price performance before the year concludes.
When you exercise ISOs in the first quarter of the year, you have a lot of time and flexibility – meet the ISO requirements, pay the AMT, or sell the shares before year end if the share price drops.
You have a lot of “options” with your options. This streamlined approach reduces stress and worry, and makes your life so much easier.