What is a Stock Swap?

This is the exchange of one equity-basedasset (shares of stock in a company) for those of another company. Generally, this is used when two companies merge and one is assumed into the other. The companies swap stock as a method of combining ownership of the companies. This is a complicated process, as it requires the accurate valuation of each companys stock and the determination of a ratio for which each companys stock will be swapped (such as 10 shares of A in exchange for 9 shares of B). It can also refer to something that happens with employees exercise stock options.

How Does a Stock Swap Work?

Sometimes companies merge with using a stock swap. Other times they exchange stock and other value (such as cash or debt). The important aspect of a stock swaps it that the IRS does not consider a stock swap to be a taxable transaction (if certain conditions are met). Basically, no gain or loss needs to be reported at deal closing. The individuals acquiring the stock have the same tax basis in the new stock that they had in the prior stock. The other definition is when an employee wants to exercise their stock options and turn them into shares. This generally arises when the employee has the option to purchase shares in the company, but does not have the cash. The employee may use the value of shares already owned to pay for the new shares. Rather than selling those shares to raise the cash to exercise the option, the employee merely swaps out the shares to pay for the exercise of the additional shares.The employee does not have to use cash to receive the new set of shares, but the swap may trigger tax liabilities.