If you’re a successful long-time investor, or someone who has made good use of your stock options, you may well find yourself in the position of holding one or more chunks of highly concentrated stock. On the one hand, this disproportionate wealth allocation puts you at substantial risk. On the other hand, selling this highly appreciated stock can cause a capital gains nightmare. What to do?
The Problem
Studies show that a diversified investment portfolio produces greater long-term wealth than a concentrated portfolio, with considerably less risk, due mainly to market volatility. In general, the volatility of a single stock is more than three times that of diversified portfolio. This greater volatility reduces the rate of compound growth, which, in turn, reduces your future wealth. In addition, your concentrated position forces you to rely on the continued good fortune of not only a single industry, but also a single company within that industry.
Unfortunately, however, the other side of the coin, i.e., selling all or a large portion of your concentrated stock so you can diversify, presents problems of its own. This is especially true if your highly concentrated stock has also highly appreciated in value since you acquired it. Today’s highest long-term capital gains tax rate is 20%, but President Biden’s American Families Plan will, if passed by Congress, raise this rate to 39.6% if you earn $1 million or more per year.
Before throwing up your hands in despair over this seeming Catch-22 situation, know that there is a solution that solves both your capital gains problem and your diversification needs: the Deferred Sales Trust (DST).
The Solution
The DST is a unique, proprietary form of the installment sale method authorized by Section 453 of the Internal Revenue Code. You sell your concentrated stock to a third-party trust, the DST, in exchange for a secured installment note that guarantees your receipt of fixed installment payments in the future. Your DST, in turn, sells your stock and invests the proceeds on your behalf. Since the sale proceeds come into the trust instead of coming to you personally, you have no capital gains exposure.
Your Independent Trustee, one of only 13 professionals in the country vetted and approved to act as such, then begins making investments on your behalf that can include virtually any type of “prudent investment,” including the following:
- Stocks
- Bonds
- Commodities
- Real estate
- REITs
- Annuities
- Life insurance
Keep in mind that you maintain control of not only the types of investments your Independent Trustee makes, but also of the terms of your installment note. You work closely with your Trustee throughout the life of your installment contract to ensure that the investments meet your goals and objectives, taking into consideration your risk tolerance. You can also, if necessary, change when and how you receive your payments. This can be particularly helpful if you retire and need additional income on which to live.
Interested? Find Out More
If you’re intrigued about the diversification opportunities a DST offers you, while allowing you to defer capital gains taxes, contact Reef Point today. We’ll be happy to answer all your questions and start you on the road to safe, diversified investments.