Qualifying disposition (ISO)
Also: qualifying disposition, ISO qualifying disposition, QD
A sale of ISO shares that meets both holding tests: more than two years from grant and more than one year from exercise. Entire gain is long-term capital gain; no ordinary income at sale.
A qualifying disposition meets both Section 422 holding tests. The sale occurs more than two years after the grant date and more than one year after the exercise date. The entire gain between strike price and sale price is long-term capital gain, taxed at 15% or 20% federal plus NIIT where applicable. No ordinary wage income is recognized at sale.
Example: 3,000 ISOs granted June 2023 at a $4 strike, exercised September 2024 at $40 FMV, sold October 2025 at $90. Grant to sale is 28 months (passes), exercise to sale is 13 months (passes). The $258,000 gain is entirely long-term capital gain. Any AMT paid at exercise in 2024 generates an AMT credit that recovers over later years as the regular tax exceeds the tentative minimum tax.
Common mistake: starting the one-year exercise clock from grant instead of exercise. The two tests are independent, and both must pass.
Qualifying dispositions matter when the employee has the cash to exercise early, the conviction to hold for more than a year, and sufficient AMT headroom to cover the exercise year.