Key Takeaways
- Capital gains and concentrated or complex holdings can expose your portfolio to additional taxes and investment risk.
- Proactive planning can help optimize after-tax returns and support long-term wealth building.
- A qualified financial advisor can help you design and implement strategies that fit your specific situation.
Without proper management, capital gains and concentrated stock positions can lead to substantial tax bills and increased portfolio risk. Fortunately, there are several strategies that can help reduce both your tax burden and your risk exposure.
Risks of Concentrated Positions
Concentrated stock positions can increase your portfolio’s risk exposure in the following critical ways:
- Sustained underperformance – Most stocks underperform their benchmark index’s risk-adjusted returns, especially in subsequent periods of outperformance.
- Elevated volatility –Since 2014, single stocks in the Russell 1000 Index average 37% volatility vs. 15% for the index.
- Material drawdowns – 85% of stocks experience larger drawdowns than the Russell 1000 Index during market declines.[1]
Risk Management Strategies
The following strategies can help reduce your tax and market risk.
- Loss harvesting –Realize losses in positions that have declined and reinvest in similar (but not identical) investments to offset gains and potentially up to $3,000 of ordinary income each year.
- Selling in low-tax years –Time large sales for years when your income is lower so that more gain is taxed at 0% or 15% rather than at higher capital gains rates.
- Charitable donations of appreciated securities –Contribute long-term appreciated stock or funds directly to charity or donor-advised funds (DAFs) to avoid the embedded gain while potentially deducting the full fair market value on your itemized tax return.
- Sell over time – Spread sales of appreciated assets across multiple years to help smooth out your taxable income and reduce the risk of pushing gains into higher brackets.
Complex Strategies
Certain situations may require a more advanced approach. Your financial advisor can help you determine whether your portfolio would benefit from the following complex strategies:
- Direct indexing/enhanced loss harvesting –Use dedicated strategies designed to closely track an index while purposefully realizing losses that can be used to offset current and future capital gains.
- Exchange funds –Contribute concentrated stock to an exchange fund in return for a diversified partnership interest, which may allow you to defer capital gains while reducing your single-stock risk.
- 1031 exchange and 721 UpREIT –For real estate, use 1031 exchanges to roll proceeds into a like-kind property, and 721 UpREITs to exchange property into operating partnership units tied to a diversified real estate portfolio.
- Options strategies for concentrated positions –Use protective puts, collars or similar option strategies to hedge downside risk or define exit prices on large single-stock positions without immediate full liquidation.
- Charitable vehicles (CRTs and similar structures) –Use tools such as charitable remainder trusts to diversify appreciated assets, create income streams, and defer or reduce capital gains while supporting your choice of charitable causes.
You might also consider the following estate planning strategies:
- Step-up in basis –Coordinate holding periods and ownership structures with your estate plan so that heirs may receive a step-up in basis at death, potentially eliminating built-in capital gains.
- GRATs – Use grantor retained annuity trusts (GRATs) to transfer appreciation on concentrated or rapidly growing assets out of your estate with limited gift tax cost.
- Strategic gifting in FLPs – Employ family limited partnerships (FLPs) to shift ownership interests to heirs using valuation discounts while retaining some control and managing estate and gift tax exposure.
For help designing and implementing a plan tailored to your situation, please schedule a call with a member of our team.
[1] https://www.morganstanley.com/articles/diversify-risks-concentrated-positions
