A concentrated stock position is often a sign that something went right. A company you founded, joined early, or bet heavily on delivered returns that have made a single holding a dominant part of your net worth. The problem is not the wealth — it is the risk. Holding 50%, 70%, or more of your net worth in a single stock exposes you to a range of outcomes that no amount of future earnings can fully offset. But the standard solution — sell the position, pay the taxes, diversify — carries its own significant cost. For a position with a very low cost basis, the federal capital gains tax alone can consume 23.8% of the position's value, before state taxes. In California, the combined federal and state capital gains rate can exceed 37%. Selling is often the right answer, but it is rarely the only answer.
Why Selling Isn't Always the Answer
The embedded capital gains in a concentrated position represent a deferred tax liability — real money owed to the IRS that will eventually come due. For a founder who acquired shares at a near-zero cost basis, the tax cost of liquidation can be staggering. A $10 million position with a $100,000 basis has approximately $9.9 million in embedded gains. At a combined 37% federal and state rate, the tax cost of selling is roughly $3.7 million. The after-tax proceeds available for reinvestment are only $6.3 million — a 37% "haircut" before a single dollar of diversified investment return is earned.
For families with significant estate tax exposure, there is an additional consideration: the stepped-up basis at death. Under current law, heirs who inherit appreciated stock receive a new cost basis equal to the fair market value at the date of death. If you die holding the position, the embedded gain is eliminated for income tax purposes. This is not a reason to hold forever — estate planning has its own costs — but it is a relevant factor in the cost-benefit analysis of selling versus managing the position strategically over time.
The goal is not to avoid ever recognizing gains. The goal is to manage the timing, character, and amount of recognition in a way that maximizes after-tax wealth over the long term.
We help executives and founders model their options — from exchange funds to CRTs — and choose the approach that fits their full financial picture.
Strategy 1: Exchange Fund
An exchange fund — also called a swap fund — allows you to contribute your concentrated shares to a partnership alongside shares contributed by other investors, each of whom has their own concentrated position. In exchange, you receive a partnership interest that represents a diversified portfolio across all the contributed positions. You achieve diversification without a taxable sale: the contribution is structured as a non-recognition event under IRC Section 721, which generally provides that contributions to a partnership are not taxable. After a required seven-year holding period, you can exit the fund and receive a diversified portfolio of securities.
The limitations are meaningful. The fund must hold at least 20% "illiquid assets" (typically real estate) throughout the holding period to satisfy statutory requirements. The seven-year lock-up is a genuine constraint on liquidity. The funds are typically available only to qualified purchasers (generally those with $5 million or more in investments), and fees can be significant. The fund manager selects which shares are accepted, and highly volatile or thinly traded positions may not be eligible. But for an executive with a large, marketable position and a charitable or estate-focused long-term plan, the exchange fund can be a powerful first step toward diversification without immediate tax cost. See our full equity compensation planning services for more.
Strategy 2: Charitable Remainder Trust (CRT)
A Charitable Remainder Trust is an irrevocable trust into which you transfer appreciated assets. The trust sells the assets — because the trust itself is tax-exempt, it can sell without recognizing capital gains — and reinvests the full proceeds in a diversified portfolio. You (and/or a named beneficiary) receive an income stream from the trust for a period of years or for life. At the end of the trust term or upon death, the remaining assets pass to one or more named charities.
The tax benefits are substantial. You receive a partial charitable deduction at the time of the contribution, based on the present value of the charitable remainder. The trust sells the concentrated position without capital gains. And you receive an income stream — either a fixed annuity (in a Charitable Remainder Annuity Trust, or CRAT) or a variable amount based on the trust's value (in a Charitable Remainder Unitrust, or CRUT). The income is taxed to you as it is distributed, using a tiered ordering system that characterizes distributions as ordinary income, capital gain, and tax-free return of basis — but the timing of the recognition is deferred and spread across the distribution period.
The CRT is best suited for individuals with genuine charitable intent, since the remainder ultimately passes to charity. If your primary goal is wealth transfer to heirs, a CRT should be paired with a "wealth replacement" life insurance policy funded by a portion of the income stream — a strategy that rebuilds the transferred wealth on an income-tax-free basis for heirs. The coordination of a CRT with your estate plan requires careful attention.
Strategy 3: Donor-Advised Fund (DAF)
A Donor-Advised Fund is the simplest and most accessible of the charitable strategies. You contribute appreciated shares directly to a DAF — a public charity that holds the assets and makes grants to other charities on your recommendation. The contribution is a completed charitable gift: you receive a full fair market value deduction at the time of contribution, and the DAF can sell the shares without capital gains. The proceeds are then deployed to charities of your choice over time, on your schedule.
The DAF does not provide an income stream (unlike a CRT), and the assets irrevocably pass to charity. But for someone who already intends to make significant charitable gifts, the DAF is an exceptionally efficient mechanism for doing so with appreciated stock rather than cash. Contributing $1 million of stock with a $50,000 basis to a DAF avoids approximately $285,000 in federal capital gains tax (at 23.8% on $950,000 of gain) while generating a $1 million charitable deduction. The economic benefit relative to selling and donating cash is substantial. DAF contributions can also be bunched across years to maximize itemized deduction benefits in high-income years — a strategy that is particularly effective in the year of an IPO or large equity liquidation event.
Strategy 4: Options Strategies
For executives who hold large blocks of publicly traded stock, options and derivatives strategies can provide partial downside protection or create liquidity without an immediate sale. Three common approaches:
Protective puts allow you to purchase the right to sell your shares at a specified price (the strike price) for a specified period. A put option on a concentrated position provides a price floor — if the stock declines below the strike, the put gains in value to offset the loss. The cost is the premium paid. Protective puts are straightforward but can be expensive for volatile stocks over extended periods. They are often used to provide a defined period of downside protection while a longer-term diversification strategy is implemented.
Collars combine a protective put with the sale of an upside call option. The premium received from selling the call partially or fully offsets the cost of the put. In exchange, you cap your upside if the stock appreciates above the call strike. A "zero-cost collar" is structured so the put and call premiums offset each other exactly, providing downside protection at no immediate cash cost. Collars must be structured carefully to avoid being treated as a "constructive sale" under IRC Section 1259, which would trigger immediate recognition of gain. Work with qualified tax counsel on the specific terms.
Prepaid Variable Forwards (PVFs) involve entering a contract to deliver shares (or their cash equivalent) at a future date in exchange for an upfront payment. You receive cash today — which can be used for diversification or other purposes — while deferring the tax recognition event to the future delivery date. PVFs are complex and must be carefully structured to avoid constructive sale treatment. They are also subject to margin and credit requirements. These instruments are used by sophisticated investors with significant positions and should be implemented only with qualified financial and tax counsel.
Strategy 5: Gradual Diversification with Tax-Loss Harvesting
The most straightforward strategy — systematic, planned selling — is also one of the most effective when combined with disciplined tax-loss harvesting. Rather than selling the entire position in one year and absorbing the full capital gains tax cost, you sell a portion each year, managing the gain recognition to avoid pushing into higher capital gains rate brackets or triggering additional surtaxes.
The effectiveness of this strategy is enhanced when you simultaneously harvest capital losses from other parts of your portfolio to offset the gains recognized on the concentrated position. Long-term capital losses can offset long-term capital gains dollar-for-dollar. A systematic tax-loss harvesting program across a diversified portfolio can generate meaningful losses each year — particularly in volatile markets — that substantially reduce the net capital gains recognized from the concentrated position sales.
This strategy requires patience. Diversifying a $10 million concentrated position over ten years means holding the concentration risk for longer than many advisors would recommend in isolation. The tradeoff between concentration risk and tax cost is real, and the right pace depends on the specific stock's volatility, your overall financial security, and your other planning objectives. In many cases, a combination of strategies — some immediate risk reduction through a collar or exchange fund, combined with systematic selling over time — is more effective than any single approach.
Choosing the Right Strategy
No single strategy is right for every concentrated position. The appropriate approach depends on your liquidity needs and time horizon, the size and nature of the position (public vs. private, marketable vs. restricted), your charitable intent, your estate planning goals, and your risk tolerance for continued concentration in the interim.
A complete analysis considers all of these factors together. An exchange fund may be optimal for a liquid, marketable position with a long time horizon and no immediate liquidity need. A CRT may be optimal for an older investor with charitable intent and a desire for income. Gradual diversification with loss harvesting may be the most practical approach for a position with modest embedded gains and strong future conviction. And in some cases, simply selling — accepting the tax cost and diversifying — is the right answer because the concentration risk is simply too high relative to the tax savings from a more complex strategy.
Our equity compensation practice helps families model each of these options with real numbers — before any decision is made. The goal is always to maximize after-tax, after-risk wealth over the long term, not to minimize any single year's tax bill.
