Executives and small business owners often struggle to figure out how to diversify a concentrated investment in company stock, due to the adverse tax ramifications of liquidating a highly appreciated investment. Which leads to strategies including variable prepaid forward contractors, exchange funds or stock protection funds to facilitate diversification, or leveraging available tax laws like Net Unrealized Appreciation to mitigate the tax consequences.
But after nearly 9 years of a bull market since the bottom in March 2009, “most” long-term investors now have substantial capital gains. Not because they held a concentrated stock investment that grew, but simply because even a diversified portfolio of mutual funds and/or ETFs may be up 100%, 200%, or even 300% since the bottom. And ironically, the more tax-efficient and “tax-managed” the fund or advisor has been all along, the less turnover there’s been, and the more likely it is to have very substantial embedded capital gains now!
And unfortunately, such large embedded capital gains create real tax complications for engaging in even routine investment adjustments like periodic rebalancing, and especially in situations where the advisor might want to switch strategies (or the investor might want to switch advisors), but “cannot” do so because of the adverse tax consequences.
On the plus side, the reality is that the tax benefits of deferring capital gains are often smaller than most investors realize, as they confuse “tax avoidance” (not recognizing the capital gains) with what really is just tax deferral (the capital gains will ultimately have to be paid if the investor is ever going to use the money).
In addition, relatively straightforward tax strategies can further help investors to get comfortable with unwinding investments with large capital gains, from establishing a “capital gains budget” for the amount of capital gains to be triggered each year (perhaps targeted to stay under the threshold for the next capital gains tax bracket), setting targets for staged sales at progressively higher (or lower) prices to help investors pre-commit to making a change, or simply engaging in a “donate-and-replace” strategy that leverages the tax preferences of contributing appreciated securities for a tax deduction (and eliminating the capital gains altogether) and then replacing the investment (as a new higher cost basis) with the cash that would have been donated in the first place!
source https://www.kitces.com/blog/strategies-highly-appreciated-investments-big-embedded-capital-gains-concentrated-stock/?utm_source=rss&utm_medium=rss&utm_campaign=strategies-highly-appreciated-investments-big-embedded-capital-gains-concentrated-stock
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