You worked hard to build wealth in that one stock. Maybe you were an early employee who got stock options. Perhaps you were gifted shares from a parent who believed in the company for decades. Or maybe you just made a great pick years ago and watched it grow.
Now you have a problem. A good problem, but still a problem. That single stock makes up a considerable chunk of your net worth. You know you should diversify. Every financial advisor tells you the same thing. But the tax bill to sell it all? Painful.
The good news is you have options. Several strategies let you reduce your concentration risk without writing an enormous check to the IRS. Let me walk you through some approaches that can help.
The hidden gem in your 401(k): net unrealized appreciation
If you have company stock sitting in your 401(k), there is a little-known tax strategy that could save you thousands. It is called Net Unrealized Appreciation, or NUA for short.
Here is how it works. Usually, when you take money out of a 401(k), you pay ordinary income tax on the entire withdrawal. Those rates can reach 37%. But with the NUA strategy, you can move company stock out of your 401(k) and pay ordinary income tax only on the original cost basis. The appreciation gets taxed at the much lower long-term capital gains rate of 0%, 15%, or 20%, depending on your income.
Let me give you an example. Say you have 2,000 shares of company stock in your 401(k) worth $200,000. Your original cost basis is $14,000. If you roll everything into an IRA and later take distributions, you pay ordinary income tax on the full $200,000.
That could mean $74,000 in federal taxes if you are in the 37% bracket.
With the NUA strategy, you transfer the stock to a taxable brokerage account. You pay ordinary income tax on just the $14,000 cost basis. When you sell the stock later, the $186,000 of net unrealized appreciation is taxed at long-term capital gains rates, while any additional gain after the distribution is taxed as short-term or long-term, depending on how long you held the shares after the distribution.
Assuming a 15% long-term capital gains rate and a 37% ordinary income tax rate, you would owe about $27,900 of capital gains tax on the NUA and about $5,180 of ordinary income tax on the cost basis—a total of roughly $33,080 in tax, instead of $74,000.
The rules are specific. You must have a qualifying event, such as separation from service, disability (under certain circumstances), death, or reaching age 59½. You must take a lump-sum distribution of your entire balance across all the employer’s qualified plans of the same type within one tax year. And you must take the company stock out in kind, meaning actual shares, not cash.
One detail many people miss: you can select specific stock lots for NUA treatment. If some of your shares have a very low basis while others have a higher basis, you can choose to apply NUA only to the low-basis shares and roll the rest into an IRA. This gives you the best of both worlds.
Sell smarter with specific lot identification
When you sell stock, which shares are you selling? This question matters more than most people realize.
Most brokerage firms default to FIFO, which stands for First In, First Out. This means they assume you are selling your oldest shares first. But those oldest shares usually have the lowest cost basis, which means the highest taxable gain.
You have another option called specific identification or specific lot selection. With this method, you choose exactly which shares to sell. If you bought stock at different times and prices, you might have some lots with a high-cost basis and others with a low-cost basis. By selling your highest-cost shares first, you can minimize your current tax bill.
Let me show you what this looks like. Imagine you own 3,000 shares of XYZ stock bought in three lots. Lot A: 1,000 shares at $20 each. Lot B: 1,000 shares at $30 each. Lot C: 1,000 shares at $40 each. The stock now trades at $35.
You want to sell 1,000 shares. Under FIFO, you sell Lot A and realize a $15,000 gain. Using specific identification, you sell Lot C and realize a $5,000 loss. That loss can offset capital gains elsewhere in your portfolio, and if losses exceed gains, up to $3,000 per year can reduce your ordinary income.
This is not avoiding taxes forever. It is managing the timing. You still have the other lots with their original basis. But controlling when you recognize gains and losses gives you flexibility in your overall tax planning.
To use this strategy, contact your broker before you place a sell order and specify which lot you want to sell. Most online platforms now let you do this yourself when you enter the trade.
Turn appreciated stock into charitable impact
If you are charitably inclined, donating appreciated stock to a donor-advised fund is one of the most tax-efficient ways to give.
Here is the double benefit. When you donate stock you have held for more than a year to a charity or donor-advised fund, you get a charitable deduction for the full fair market value of the shares. And you pay zero capital gains tax on the appreciation. The charity sells the stock tax-free and invests the proceeds.
Compare this to selling the stock and donating cash. If you sell $100,000 worth of stock with a $10,000 cost basis, you owe $21,420 in federal taxes at the 23.8% rate that includes the net investment income tax. You donate the remaining $78,580. Your charitable deduction is $78,580.
If you donate the stock directly, the charity gets the full $100,000. Your deduction is $100,000. You pay no capital gains tax. You come out ahead, and so does the charity.
For long-term appreciated assets donated to a public charity or donor-advised fund, the deduction is generally limited to 30% of your adjusted gross income, with any excess carried forward for up to five years. A donor-advised fund works like a charitable checking account. You donate and get your deduction now. Then you recommend grants to your favorite charities over time. This is especially useful if you want to bunch several years of charitable giving into one year to exceed the standard deduction.
One important rule: donate your most appreciated shares. Look at your portfolio and identify the stocks with the lowest cost basis relative to current value. Those are the ones that give you the most significant tax benefit when donated.
Get income and give to charity with a charitable remainder trust
A charitable remainder trust, or CRT, is a more sophisticated tool for those who want to diversify, reduce taxes, and still receive income from their appreciated stock.
Here is how it works. You transfer appreciated stock into an irrevocable trust. The trust sells the stock without paying capital gains tax because it is a tax-exempt entity. The trust then reinvests the proceeds in a diversified portfolio. You receive income payments from the trust for life or for a set number of years. At the end, the remaining assets go to charity.
The benefits are significant. You get an immediate partial income tax deduction based on the present value of the charitable remainder. The trust can sell the stock and reinvest without triggering capital gains tax. You receive income for as long as you need it. And you support causes you care about.
As you receive payments from the trust, each distribution is taxed under the four-tier system, meaning portions may be taxed as ordinary income, capital gains, tax-free income, or return of principal, depending on the trust’s earnings. But spreading that tax over many years often results in lower total taxes because you stay in lower brackets.
There are two main types. A charitable remainder annuity trust pays a fixed dollar amount each year. A charitable remainder unitrust pays a fixed percentage of the trust value, recalculated annually. The unitrust provides inflation protection because payments rise as investments grow.
CRTs work best for those with highly appreciated assets who need income and have charitable intent. The setup costs and ongoing administration make them usually only sensible for larger contributions typically $300,000 or more.
Spread out your tax bill with an installment sale
An installment sale lets you spread your capital gains tax over multiple years rather than paying it all at once.
Under IRC Section 453, when you sell property and receive at least one payment after the year of sale, you can report the gain proportionally as you receive payments. This can keep you in lower tax brackets and reduce your overall tax burden.
One caution: the installment method does not apply to stock traded on an established securities market. You cannot use it to sell your publicly traded shares directly. However, a more sophisticated structure, a Deferred Sales Trust, can achieve a similar result.
With a Deferred Sales Trust, you sell your appreciated asset to a trust in exchange for an installment note. The trust sells the asset to the ultimate buyer and invests the proceeds. You receive payments over time in accordance with the note terms. You pay capital gains tax only as you receive principal payments.
Deferred Sales Trusts are not specifically approved by the IRS, rely on private rulings and legal interpretation, and require careful structuring due to audit and legal risk. The IRS scrutinizes these arrangements, and they must be properly documented to work. Setup costs are high, so this typically makes sense only for sales of $1 million or more.
For non-dealer installment obligations exceeding $5 million, IRC Section 453A imposes an interest charge on the deferred tax attributable to the portion above $5million. The interest accrues at the IRS underpayment rate and reduces but does not eliminate the benefit of spreading payments over time.
Diversify without selling through exchange funds
Exchange funds offer a way to diversify a concentrated stock position without triggering any immediate tax.
Here is the concept. You contribute your appreciated stock to a partnership along with other investors who contribute their concentrated positions. In return, you receive a proportional interest in the diversified pool of stocks. The tax deferral depends on the exchange fund meeting the requirements of IRC Section 721, including limits on the types of assets contributed and the composition of the diversified portfolio.
After a minimum holding period of seven years, you can redeem your interest. Instead of getting cash, you receive a diversified basket of stocks representing your share of the fund. Your original cost basis gets allocated across those shares. You only pay capital gains tax when you eventually sell the distributed shares.
Exchange funds are typically available only to accredited investors, generally meaning individuals who meet specific income or net worth thresholds under SEC rules. Minimum investments often start at $500,000 or more. The seven-year lock-up period means your money is illiquid during that time.
For those who qualify, exchange funds provide immediate diversification with complete tax deferral. You get out of your concentrated position and into a broad portfolio without writing a single check to the IRS until you are ready.
The hardest part is often not the taxes
The biggest obstacle to diversifying is often not the tax bill. It is the emotional attachment to the stock.
If you built a career at a company and received stock over many years, those shares represent more than money. They represent your professional identity, your contributions, and your relationships with colleagues. Selling can feel like betraying that history.
If you inherited the stock from a loved one, the emotional weight is even heavier. Your parent or grandparent believed in that company. They held those shares for decades. Selling might feel like disrespecting their legacy.
There is also the fear of regret. What if you sell and the stock doubles? You would kick yourself. Psychologists call this regret aversion. The pain of a potential missed gain often feels stronger than the security of having a diversified portfolio.
Here is what I tell clients who struggle with these feelings. Your financial security does not require loyalty to a single company. Diversification is not a prediction that the stock will go down. It is an acknowledgment that you cannot know the future. Even the best companies face unexpected challenges.
Think about it this way. If someone handed you cash equal to your stock position today, would you put it all into that one company? Probably not. The only reason you hold such a concentrated position is because of how you got there, not because it is the right allocation for your goals.
You do not have to sell everything at once. A phased approach works for many people. Sell a percentage each year. Use the strategies above to minimize taxes along the way. Over time, you build a more balanced portfolio without the shock of a single big sale.
Finding the right combination for your situation
Most people benefit from using several of these strategies together rather than relying on just one.
Start with the tax-free options. If you have company stock in a 401(k), evaluate whether NUA makes sense. If you are charitably inclined, donate your most appreciated shares to a donor-advised fund.
Then look at tax-efficient selling. Use specific lot identification to minimize gains. Time your sales across multiple years to stay in lower tax brackets. Harvest losses elsewhere in your portfolio to offset gains.
For larger positions, consider more sophisticated tools. Exchange funds if you qualify and can accept the lock-up period. Charitable remainder trusts are for those who want income and have charitable goals. Deferred sales trusts if you need maximum flexibility on timing.
The right combination depends on your specific situation. Your tax bracket, your time horizon, your liquidity needs, your charitable intent, and yes, your emotional readiness all play a role.
Whatever approach you take, the most important thing is to take action. A concentrated stock position is a bet on one company with money you cannot afford to lose. Diversification is how you protect the wealth you have worked so hard to build.
The tax strategies exist to make that transition easier. Use them.
