In today’s episode, you’ll learn more about:
- How a Section 351 exchange into an ETF can provide diversification while deferring capital gains
- How tax-aware long-short strategies can help create ongoing tax offsets while gradually reducing a concentrated position
- When Net Unrealized Appreciation may apply to company stock inside a 401k
- How donor-advised funds and charitable planning can reduce capital gains on appreciated shares
Listen Now:
The Smart Take:
A strong market can create a new problem. A single stock or ETF grows to represent a large portion of your net worth. Now you face a difficult tradeoff: diversify and trigger a large tax bill, or hold the position and accept concentrated risk.
In this episode, Tyler Emrick, CFP®, CFA®, walks through practical strategies for managing concentrated stock positions in a tax-efficient way.
This is not about eliminating taxes entirely. It is about reducing single-stock risk with a disciplined and tax-aware process.
If you have a large position in employer stock, a long-held individual name, or a highly appreciated legacy holding, this episode will help you think through your options more strategically.
Go Inside the Episode:
0:00 – Intro
3:13 – 351 Exchange
7:29 – Tax Aware Long Short strategy
10:35 – NUA for Company Stock
15:53 – Gifting
Go Deeper into Tax-Aware, Long-Short (TALS™) Investing Strategy:
Part 1: The Long and Short on Tax-Aware, Long-Short (TALS™) Investing
Part 2: The Long and Short on Tax-Aware, Long-Short (TALS™) Investing
Part 3: The Long and Short on Tax-Aware, Long-Short (TALS™) Investing
Learn more about the Retire Smarter Solution ™: https://www.truewealthdesign.com/ep-45-retire-smarter-solution/
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The Hosts:
Kevin Kroskey, CFP®, MBA – About – Contact
Tyler Emrick, CFA®, CFP® – About – Contact
Episode Transcript:
Tyler Emrick:
If you own stock that has done extremely well, you may have a new problem. Selling could trigger a large tax bill. Holding could leave you dangerously concentrated. In this episode, we’ll walk through practical tax smart ways to reduce your concentrated stock position without unnecessarily accelerating taxes.
Walter Storholt:
Back again on Retire Smarter. Walter Storholt, alongside Tyler Emrick, Certified Financial Planner, Chartered Financial Analyst, and one of the wealth advisors at True Wealth Design, based in Northeast Ohio, but serving you all across the country with clients all over the place. You can go to truewealthdesign.com or click the link in the description of today’s show to schedule a 20-minute discovery call with the team to see if you’d be a good fit to work with one another. And Tyler, I’m kind of bummed out, man. Here I am. You’re saying I’ve done well. I have a nice big gain in my stock pick. And now I’ve got new things to worry about. I just thought I was going to go party, so I’m a little upset.
Tyler Emrick:
Yeah, good old Uncle Sam, right? Always looking over your shoulder.
Walter Storholt:
Yeah.
Tyler Emrick:
Tax [inaudible 00:01:10].
Walter Storholt:
So, more money more problems is like the underscored title for today’s episode, right?
Tyler Emrick:
Yeah. And not to say the least. Well, I mean, you look back, Walt, I mean the last few years, the stock market has just been wonderful from a performance standpoint. I mean, really you’d have to go back to what, 2022 to see a calendar year where the stock market just in general has performed negatively. Anytime we experience prolonged periods of good performance like that, we have individuals and families that run into situations where those individual investments, stocks, even mutual funds and ETFs can appreciate in value. And of course, if you hold those investments in taxable brokerage accounts, so anything really outside of retirement accounts, like IRAs and Roths, when you sell those investments, good old Uncle Sam comes calling and you got a tax bill, Walt. So, today, we want to talk about how do we help lessen the pain of that tax bill when you do go and sell out of some of those highly appreciated positions.
Walter Storholt:
Yeah. I think this will be helpful. And especially if a lot of people are in that position. And it makes sense. If I’ve, let’s say, got a large allocation in something, it doubles or triples over a couple of years. Well, I once was balanced and now I’m very easily out of balance. And then a huge increase that I’ve got to now account for. Not that we want to be scared of making money because we’ve got to pay taxes on it, but if there’s a smarter way to approach it, I think people will be all ears.
Tyler Emrick:
Correct. Well, and I think more often than not, Walt, when we talk to families in this situation, they’re like, “Well, hey, I’ve held it for years. I inherited it from a family member, and I just never sold it and it just… Hey, it did very well. And now it’s become a much, much larger piece of my overall pie than I expected it to be.” And it’s like, “Well, hey, what options do I have other than just selling, cutting the cord and paying the bill.” So, we really want to try to focus on, well, what options do you have? There’s no perfect solution, but there are a multitude of options that, depending on your situation, could really work out well and do some wonders. So, the first one would be 351 exchange. Sounds kind of official, doesn’t it? And very technical. 351 exchange and specifically doing that into an ETF structure.
So, Walt, this would be for individuals that maybe you have a stock that has, again, appreciated in value tremendously and you don’t want to sell it, but what happens is, is there’s a multitude of companies that you can go to. What they do is they pool all these individual stocks together. So, there’s many other families potentially in the same situation that you are. And they don’t want to sell with a big tax hit, but they really want to diversify over their risk. They don’t want to have all that exposure into one particular stock. So, what they’ll do is they can move some of those concentrated stock positions into an ETF, which many other individuals do the same thing.
And then the goal would be, hey, what you’re left with is shares of an ETF that is more appropriately diversified to where it’s not just all in one stock. But if we have a multitude of families and individuals contributing to this ETF, eventually we will have a portfolio that would be much, much more diversified than just holding on the one particular stock. So, when you do something like this, when you move those shares into the new ETF, and do the 351 exchange, that is not a taxable event, Walt. So, you’re not necessarily selling and then moving cash. You’re just actually moving the shares that you own into this new ETF. And what you’re left with are shares of the new diversified ETF.
And from a fee standpoint, they’re very comparable to just any other traditional ETF that you would get off the street, that would be indexed based off of the S&P 500 or Russell 3000 or whatever. So, it can be a tremendous benefit for individuals that are really trying to focus on, hey, I want to diversify out of this concentrated stock position. How can I do it? I want to move it into an ETF structure through a 351 exchange.
Walter Storholt:
And in a way, you’re sort of not locking in, but you’re capturing some of those gains, but then you’re also eliminating some of that huge downside of owning a bunch of one stock, that could just as easily give it all back by then diversifying into multiple options again.
Tyler Emrick:
Correct. And then since it’s just a traditional ETF beyond that point, pay. You can always sell out of that ETF or shares down the road. Obviously, you didn’t get rid of the gain. Your gain is still there.
Walter Storholt:
There’s still going to be a tax bill, but you’ve maybe pushed it down the road.
Tyler Emrick:
You certainly have pushed it down the road. And really, what you’ve gained is you’ve gained diversification.
Walter Storholt:
Without having to pay the taxes to achieve it.
Tyler Emrick:
You nailed it. Exactly right. Now there are some downsides here. One of the big downsides is that, hey, if you’re trying to contribute a stock that everyone else has and is trying to contribute to that ETF, well, that can run into some issues. So, a lot of times when you look at maybe utilizing a strategy like this, there will be rules that you need to follow to say, hey, you might only be able to do certain stocks or certain amount. Or you might have to contribute to the ETF, not only your concentrated stock positions, but maybe a few other positions to balance it out. Because as you think about the exchange fund or ETF itself, excuse me, it’s obviously got to be diversified as well. So, if everybody is trying to put in NVIDIA stock, that’s not going to necessarily work.
So, that can be one of the downsides or harder things to work around, especially if you have a concentrated position in a lot of the big stocks that have done very well over the last couple handfuls a year and everyone’s trying to do the same thing.
Walter Storholt:
It’s very much this very community-based decision that you’re making when you go into one of these kinds of ETFs, it sounds like. You’re personally affected by what other people are doing into that account.
Tyler Emrick:
And putting into it. Yep. So, the individuals and the companies that are setting these up, they’ll give you a list of guidelines and rules. That’s where a good financial advisor is going to come into play saying, “Hey, what options do we have out there to do this? What are some of the rules that we need to follow and can it be applicable in your particular situation?” So, a wonderful, wonderful option if it works.
Walter Storholt:
Okay, cool.
Tyler Emrick:
But let’s say you have some of that stock. Maybe you have the NVIDIA and you can’t use the 351 exchange. What other options are out there? And the other big one that comes to mind is something that we’ve talked about at length on the podcast and on YouTube, which would be this idea of tax-aware long/short investing, right?
Walter Storholt:
We’ll link to our series on that, by the way, in the description of today’s show, if you want to go deep dive into that. I know you’re going to hit some highlights here.
Tyler Emrick:
Highlights. Yep. No, you’re absolutely right. But the general premise is, is that we can use these tax-aware long/short investing accounts to harvest portfolio losses over an extended period of time. And if we can harvest enough of those losses, we can treat that as a tax asset. And then we can use it to then systematically sell down out of your concentrated stock position. So, unlike the 351 exchange, Walt, where, hey, certain stocks got to have certain rules that you follow, the tax-aware long/short strategy doesn’t have any of those guidelines. You do have to have other assets that are outside of retirement accounts. So, you’d have to have a built up asset base outside of retirement accounts.
But if you do that, you can use those to then leverage this long, short strategy, which in theory, we should be able to harvest those losses and then again, use them to systematically sell down out of the concentrated stock position. That is a wonderful, wonderful tool and probably one of the ones that we’ve used the most over the last couple years here, as we think about, well, hey, what is the most efficient and most widely available to families’ use for this situation? Now, again, when we look at the tax-aware long/short, it doesn’t have to be necessarily just concentrated stock positions. Walt, this could be, hey, I have an S&P 500 index fund that I’ve had for 15 years and it’s appreciated in value.
So, it’s very diversified, but I would like to be able to sell out of some of it to use it for spending in retirement. Or I’d like to be able to sell out of it and maybe diversify into international investments or something else, but I don’t want the big tax hit. So, diversification might not be our number one goal. We just want to use that capital for something else without realizing the big gain. That’s where something like the tax aware, long short could even be better than a 351 exchange, because it actually allows us to sell down those positions and then free up capital for deploying somewhere else. So, wonderful tool in the toolbox for sure.
Speaker 3:
What would your life look like if you designed it around your true wealth? It’s a powerful question and one that True Wealth Design helps individuals, families, and business owners answer every day. With a fully integrated approach to financial planning, tax strategy, investments, and business advisory, their team can bring clarity and confidence to every part of your financial life. Take the first step toward a stronger financial future with a no cost, no obligation discovery meeting. Just click the link in today’s show description to get started.
Walter Storholt:
Excellent. All right. So, we’ve so far got the 351 exchange option for this concentrated stock. We’ve got the tax-aware long/short or towels, as Kevin always liked to coin it as. What other options?
Tyler Emrick:
Yep. So, the next option is for a little bit more of a specific use case. And this would be for an individual that maybe worked for a company, and they invested in their company’s stock inside of their 401(k) and that stock did very, very well.
Walter Storholt:
So, outside of that brokerage account. We’re specifically in the 401(k) here?
Tyler Emrick:
Specifically in the 401(k), you are 100% correct. And this would be for… Here in Northeast Ohio, this would be companies like Sherwin-Williams, Progressive, companies like that, that their stock have just done tremendously well, and they give their employees an option to actually invest in that individual stock inside of their 401(k). And what we call this strategy is net unrealized appreciation or NUA for short. And what the strategy allows you to do is it allows you to take that concentrated stock position, and move it out of your 401(k), and get some very preferential tax treatment. So, let’s run through a scenario. I had a family where they had Sherwin-Williams stock. It had done very well. Actually, it had grown to about a million dollars inside of the 401(k) that they had had, but they had only paid a fraction of that for the actual stock shares themselves.
Roughly around $100,000. So, they put in 100 grand, it grew to a million. If we were to take that million dollar position inside the 401(k) and pull it all out, that would be a $1 million ordinary income tax bill, Walt. Pretty hefty.
Walter Storholt:
It’s going to hurt a little bit.
Tyler Emrick:
It would hurt. It would hurt. What we can then do through NUA is we can actually take that million dollars of stock completely out of the 401(k) and only pay ordinary income tax on the cost basis. So, $100,000 in this scenario. The other $900,000 in gain is not taxed when you pull it out of the 401(k). So, hey, we’re able to get a million bucks out of my 401(k) and only pay ordinary income tax on 100. That’s a big deal, a very big deal from a tax saving standpoint if it’s available to you. Then what happens is, is then you still have your million dollars of stock, but it would be moved into just a typical taxable brokerage account.
And then what you can do is gradually sell that over time. Maybe you can move it into a 351. Certainly, you could maybe do our towel strategy that we talked about earlier. But then you sell that stock at long-term capital gains rates. Which for the family that I’m thinking about here, we actually were able to sell it out at 0% gradually over a period of years, because we were able to manage their income low. So, you could go from paying ordinary income tax on all that money to just paying long-term capital gains, which for some individuals is zero. It could be upwards of 23% depending on your income level and all that.
But generally speaking, it’s going to be much, much lower than ordinary income. So, this NUA strategy certainly has some rules that you need to follow, some timing considerations and everything like that. So, definitely work with an advisor or make sure you feel very, very comfortable about the rules and that you’re not messing yourself up from a tax standpoint. But Walt, being able to get a million dollars out of a 401(k) account and only pay ordinary income tax on 100 grand is almost like a cheat code when you think about tax savings and being able to take advantage of the tax code for sure.
Walter Storholt:
I’m just trying to do quick math in my head, but I mean, I’m getting very quickly up to tens of thousands of dollars saved, if not over into the six digits.
Tyler Emrick:
It can be. Yeah. I remember when I really started my career, I remember when I first learned this, my eyes were just like, “What? This is a thing? The IRS allows this to happen. Are you going to be kidding me?”
Walter Storholt:
There’s a reason the tax code’s eight billion pages long. It’s because it’s got a few of these things in there.
Tyler Emrick:
You would’ve thought that I had learned the key to everything when I learned about net unrealized appreciation, some of the impact that it can have.
Walter Storholt:
This is some of the creative planning that it takes, though, to maximize your opportunities though. If it’s there in the tax code and we can utilize it legally, go for it.
Tyler Emrick:
Absolutely. Well, it goes back to that whole like, hey, are you working with someone that kind of knows everything about your situation, and are looking at the tax, and the investment and side of things and just making sure that everything is married together to put yourself in a great outcome? And net unrealized appreciation is very obscure. And I would venture to guess that no, not even every advisor runs into it or works with it. Certainly, if you have companies or families that work at a particular company that is appreciated in value and they run into it quite a bit. But when it works and if it’s at your specific situation, I mean, it’s just a tremendous, tremendous tool in the toolbox for sure.
Walter Storholt:
And one last point on that one, just to be clear, we’re not talking about just any old big 401(k) balance where you can go and do this. We’re talking very specifically about the company stock in that 401(k).
Tyler Emrick:
Within the 401(k). Yeah, you are exactly correct there. And then we’ll finish up with, I guess, two other ones that I did want to put on people’s radar, maybe a little bit less impactful depending on your situation. But if you are very charitably inclined and you have highly concentrated stock positions, that is a wonderful way to gift those appreciated stock to donor advised funds. Because then when you gift them to a donor advised fund, you can gift the shares. You don’t have to pay taxes on selling out of the stock. So, it’s a wonderful way to do your gifting if it’s applicable. Or for those families that are looking for some more complex or maybe have some other estate issues that they’re looking at, a charitable remainder trust is another vehicle to use. We’re not going to dive into either one of those, but certainly have them on your radar.
And if you’re charitably inclined, those can also be wonderful ways to slowly diversify out of some concentrated stock positions or really just highly appreciated positions in general that you’ve held for a number of years and you don’t want to sell, because you don’t want to take the tax hit. But of course, Walt, we’re gifting them, so that has to be part of what you’re trying to accomplish.
Walter Storholt:
Yeah. Yeah, absolutely. Good nuances abound in all of these options. And we’re not talking exactly about magic here, although that NUA win certainly. I know it has that feeling a little bit to it, but lots of flexibility that maybe people don’t realize is out there to take advantage of these opportunities. If you’ve got that concentrated stock, just know that you don’t have to default to the option of just holding it or just selling it all and getting the tax hit. There’s other levers that can be pulled,. And it’s always good to look at those things in the context of your overall financial plan and situation as well. That’s all part of the 20-minute discovery call that Tyler and the team at True Wealth Design run for new clients. And so, if you’d like to take advantage of that, you can do so very easily.
Click the link in the description of today’s show to schedule that time to visit for your 20-minute discovery call, to see if you’re a good fit to work with one another, where some of the gaps might be in your planning and where some of the opportunities are. It’s always at truewealthdesign.com as well. But again, we’ve got it conveniently linked for you in the description of today’s show, so just click there. Whether you’re watching on YouTube or listening on your favorite podcasting app, should be easy to find and then get in touch and set up that time to visit from wherever you are. Tyler, great breakdown today. Appreciate it all. Hope you have a great rest of your week, my friend.
Tyler Emrick:
Yeah, absolutely. You too. Have fun.
Walter Storholt:
All right. Take care, everybody. Thanks for joining us on Retire Smarter. If you’re watching on YouTube, don’t forget to hit the like button and subscribe so you don’t miss future episodes. Until next time, thanks for joining us.
Speaker 4:
Information provided is for informational purposes only and does not constitute investment tax or legal advice. Information is obtained from sources that are deemed to be reliable, but their accurateness and completeness cannot be guaranteed. All performance reference is historical and not an indication of future results. Benchmark indices are hypothetical and do not include any investment fees.