Tax-Efficient Diversification: How to Unwind a Concentrated Stock Position

The Concentration Problem: When a Single Stock Becomes a Risk

Concentrated stock positions are often a sign of success—a founder whose startup went public, an executive who held company stock through decades of appreciation, or a startup employee whose equity vested at exactly the right time. But what creates wealth can also destroy it if left unmanaged.

When a single stock represents more than 10% to 15% of your total net worth, you are exposed to idiosyncratic risk: the possibility that events specific to that one company—an earnings miss, a regulatory change, executive misconduct, or a competitive disruption—can cause devastating losses that a well-diversified portfolio would have absorbed with far less damage.

The challenge is that unwinding a concentrated position is not simply a matter of selling shares. For most investors in this situation, those shares have appreciated significantly, and selling them outright would trigger a substantial capital gains tax bill. The cost of diversification, in the short term, can feel prohibitive.

At United Financial Planning Group, we help clients with concentrated positions think systematically about how to de-risk over time in a way that is tax-aware, aligned with their values, and integrated with their broader financial plan. Here is a comprehensive framework for thinking through the problem.

Why Concentration Is a Genuine Risk

Before outlining solutions, it is worth internalizing the risk. The data on individual stocks is sobering: a substantial percentage of individual stocks underperform the broader market over long periods, and a meaningful percentage eventually lose most or all of their value. The companies most people hold in concentrated positions—former high-fliers in technology, finance, or healthcare—are not immune to these dynamics.

Beyond return risk, concentrated positions can create:

• Liquidity risk: If the position is in a private company, you may be unable to sell at all until a liquidity event that may never come.
• Retirement plan risk: If your retirement security depends on the continued value of a single stock, a sharp decline can compromise your ability to retire on schedule.
• Estate planning complications: A highly concentrated estate creates complexity for heirs and may trigger forced sales at inopportune times.
• Emotional anchoring: Investors frequently hold concentrated positions long past the point of prudence because of loyalty to an employer, fear of taxes, or anchoring to a prior peak price. These behavioral biases are not a strategy.

The Core Tax Challenge

The primary obstacle to unwinding a concentrated position is usually the embedded capital gain. If you hold shares with a very low cost basis—common for founders, early employees, or long-tenured executives—selling those shares triggers a capital gains tax on the difference between your cost basis and the current market price.

Federal long-term capital gains rates top out at 20% for high earners, and the 3.8% Net Investment Income Tax may apply, bringing the federal rate to 23.8%. For New York residents, state and city taxes add another 10% to 14% on top of that. An investor with a $5 million position and a near-zero cost basis could face $1.5 million or more in combined taxes on a full outright sale—a real cost that must be weighed against the risk of remaining concentrated.

The goal of tax-efficient diversification is not to avoid taxes forever, but to manage the timing and pace of recognition in a way that makes economic sense and fits within a long-term plan.

Strategy 1: Disciplined Systematic Sales

The most straightforward approach is simply to sell a portion of the concentrated position each year, thoughtfully timed to manage your annual tax liability.

The key discipline is having a plan before you start. Decide in advance:

• What target allocation you want to reach (e.g., reduce from 60% of portfolio to under 15% over five years).
• How much in capital gains taxes you are willing to recognize in each year.
• Whether you want to accelerate sales in years where other deductions (charitable gifts, business losses) offset gains.

Systematic selling works best when combined with other strategies below, particularly charitable giving, to reduce the net tax cost of each tranche sold.

Strategy 2: Rule 10b5-1 Plans for Executives and Insiders

Corporate insiders—executives, directors, and employees with regular access to material non-public information (MNPI)—face a specific obstacle: they are frequently prohibited from trading during blackout periods and may rarely be “in the window” to sell. This makes ad hoc selling nearly impossible.

A Rule 10b5-1 plan, established under SEC rules, solves this problem. The insider establishes a pre-arranged trading plan when they are not aware of MNPI. The plan specifies the amount, price, and timing of future sales. Once the plan is in place, the sales execute automatically according to the predetermined schedule, regardless of whether the insider is in a trading window or in possession of inside information.

Post-2023 SEC rule changes introduced a mandatory cooling-off period before the first sale can occur under a new 10b5-1 plan (typically 90 days for non-CEO/CFO insiders, and the later of 90 days or the next quarterly earnings release for CEOs and CFOs). These changes reinforce the importance of working with legal counsel and a financial advisor when establishing the plan.

Strategy 3: Donating Appreciated Stock to a Donor-Advised Fund

For investors with charitable intent, donating appreciated stock directly to a Donor-Advised Fund (DAF) is one of the most tax-efficient moves available. Here is why it is so powerful:

• You receive a charitable deduction equal to the fair market value of the shares (not your cost basis) in the year of donation, subject to applicable AGI limits.
• You permanently avoid the capital gains tax you would have owed on a sale.
• The DAF sells the shares and reinvests the proceeds in a diversified portfolio, which continues to grow tax-free inside the fund.
• You can then recommend grants from the DAF to your chosen charities over time—immediately or over many years.

Consider an example: you hold $200,000 in a stock with a $10,000 cost basis. If you sell, you pay capital gains taxes on $190,000 of gain. If instead you donate those shares to a DAF, you avoid the capital gains entirely, claim a $200,000 charitable deduction, and the full $200,000 is available to support your charitable goals. Replacing the donated shares in your portfolio with a diversified investment simultaneously reduces your concentration without selling.

DAF donations are a core tool in the annual tax planning process for any high-net-worth investor with significant unrealized gains and philanthropic intentions.

Strategy 4: Exchange Funds

An exchange fund (sometimes called a swap fund) is a sophisticated strategy for investors with very large, very low-basis concentrated positions who want to achieve diversification without immediately triggering capital gains.

The mechanics: multiple investors each contribute their different concentrated stock holdings into a limited partnership or limited liability company. Each investor receives a pro-rata interest in the combined, diversified pool. Under Section 721 of the Internal Revenue Code, this contribution is generally treated as a tax-deferred exchange rather than a taxable sale.

Important constraints:

• Investors must hold their fund interest for at least seven years before withdrawing, or the deferred gain becomes taxable.
• At least 20% of the fund’s assets must be in qualifying “nonmarketable” assets (typically real estate or other illiquid investments).
• Exchange funds are generally available only to qualified purchasers (typically individuals with $5 million or more in investable assets).
• Management fees and structural complexity are higher than standard investment accounts.

Exchange funds are not a fit for everyone, but for an investor with a $10 million or $20 million position and a near-zero basis who wants diversification and can accept a seven-year lockup, they can be genuinely transformative.

Building the Complementary Reinvestment Portfolio

Diversification is not just about removing risk—it is about rebuilding it intelligently. As you reduce your concentrated position, the proceeds (whether from systematic sales, charitable replacement, or other strategies) need to be reinvested into a portfolio that is deliberately constructed to complement what you still hold.

This means:

• Factor exposure: If your concentrated position is in a large-cap US technology company, your reinvestment portfolio should underweight large-cap US technology to avoid doubling down on the same risk factors.
• Asset class diversification: Adding exposure to international equities, small-cap, value, fixed income, and real assets that are lowly correlated with your concentrated position.
• Tax-loss harvesting opportunities: A well-managed diversified portfolio creates ongoing opportunities to harvest losses that can offset the gains recognized as you gradually sell the concentrated position.

Putting It All Together: An Integrated Approach

No single strategy is optimal for every investor. The right plan depends on:

• The size of the position and the embedded gain.
• Whether the stock is publicly traded (liquid) or private (illiquid).
• Whether you are a corporate insider subject to trading restrictions.
• Your charitable intentions and timeline.
• Your overall tax situation, including other income and deductions.
• Your estate planning goals—if you intend to leave the shares to heirs, a stepped-up cost basis at death eliminates the capital gains entirely.

Most clients benefit from a combination of strategies deployed in a coordinated, multi-year plan. At United Financial Planning Group, our CFP® professionals, CPAs, and investment managers work together to model these scenarios, stress-test your financial plan against adverse scenarios for the concentrated position, and execute a tax-aware diversification roadmap that makes sense for your specific situation.

If you hold a concentrated stock position and are unsure where to start, we would welcome a conversation. Contact us here or learn more about our investment management services.

Disclosures

This article is provided for general educational and informational purposes only. It does not constitute investment, tax, legal, or accounting advice, and nothing here should be construed as a solicitation or recommendation to buy or sell any security. Tax laws are subject to change. Strategies involving charitable vehicles, exchange funds, and insider trading rules are complex and fact-specific. Readers should consult qualified legal, tax, and investment professionals before taking action.