Managing concentrated wealth, capital gains, and the decisions that come next
The stock you bought years ago is now a significant part of your net worth. The company you built is attracting buyers. An investment property has appreciated enough that selling could help fund your next chapter.
These are meaningful accomplishments. They can also create a difficult financial decision: how do you turn that success into greater flexibility while managing the potential tax consequences?
For business owners, executives, and families with substantial taxable wealth, that question deserves attention before a transaction takes place. Taxes influence how much capital remains available. Concentration influences how much wealth is exposed to a single investment. Timing influences which planning opportunities may be available.
Considering those factors together can help you make a more informed decision about what comes next.
The cost of holding on
An appreciated investment can become difficult to sell precisely because it has performed so well.
Consider an executive whose company stock represents a substantial share of the family’s investments. Selling would create capital gains. Holding maintains the investment and leaves the family exposed to the fortunes of one company.
That exposure may extend beyond the portfolio. Salary, bonuses, future equity compensation, and career prospects may already depend on the same employer.
A useful starting point is to ask: If this money were sitting in cash today, how much would I choose to invest in this company?
The answer can reveal a gap between the portfolio you have and the portfolio you would deliberately build.
A tax bill is a visible cost. The risk of remaining concentrated is harder to measure, but it belongs in the same conversation. A thoughtful plan considers both.
What tax-loss harvesting actually does
Tax-loss harvesting involves realizing investment losses that may be used to offset realized capital gains, subject to tax rules.
For a simplified example, suppose an investor realizes $500,000 in capital gains and has $100,000 in usable realized capital losses. Assuming those losses can fully offset the gains, the net capital gain would be $400,000.
The $100,000 loss reduces the amount of taxable gain. The resulting tax savings depend on the applicable tax rates and the investor’s circumstances. IRS guidance on capital gains and losses.
This example illustrates tax netting only. It does not represent an investment result or expected strategy outcome. Actual treatment depends on the character of gains and losses and applicable tax rules.
An investment manager may reinvest the proceeds with the aim of maintaining the portfolio’s intended exposure. This requires care: purchasing substantially identical securities within 30 days before or after a loss sale can trigger wash-sale rules and disallow the current deduction. Transactions in other accounts can also matter. IRS Publication 550.
The value of a harvested loss depends on whether it can be used under applicable tax rules and how the transaction affects the overall investment plan.
Why individual holdings can create more opportunities
A portfolio can rise in value while some of its individual investments decline.
Direct indexing takes advantage of that distinction. Rather than owning only a fund that tracks an index, an investor owns a portfolio of individual stocks designed to approximate that index. A manager can potentially harvest losses in selected holdings while keeping the broader portfolio invested. Nuveen’s explanation of direct indexing.
This helps explain how an investor might have positive overall investment performance and still realize tax losses along the way.
However, the opportunities depend on market conditions and the portfolio’s holdings. Replacement investments may perform differently, and trading costs can reduce the potential benefit. An older portfolio with substantial embedded gains may have fewer available losses. A large liquidity event may also create gains that exceed what traditional harvesting can reasonably offset.
Those limitations are part of determining whether an additional tax-management approach merits consideration.
Where long/short strategies enter the conversation
In Auric’s webinar with Brooklyn Investment Group, Bill Schellenberg and Erkko Etula discussed tax-advantaged long/short strategies as one possible approach to managing substantial capital gains.
These strategies combine stocks held long with stocks sold short. A short position generally benefits when a stock declines and loses value when it rises.
A “130/30” structure illustrates the mechanics. For each $1 million of investor capital, the portfolio might hold approximately $1.3 million in long positions and $300,000 in short positions. That creates $1.6 million in gross dollar exposure and $1 million in net dollar exposure.
These figures illustrate portfolio structure only. Net dollar exposure does not establish the portfolio’s actual market sensitivity or risk.
The additional positions can create more opportunities to realize losses, including losses on short positions when stocks rise. They also introduce leverage, short-selling risks, and costs. Harvested losses and tax benefits are not guaranteed, and costs or investment losses may outweigh any tax benefit. Nuveen’s long/short strategy overview and risk disclosures.
For an investor with appreciated stock, usable harvested losses may help offset gains as the original position is gradually sold. For someone receiving business-sale proceeds, losses generated in an investment portfolio may help offset eligible capital gains from the transaction.
The amount and timing of those losses are uncertain. The approach requires evaluation of the investor’s tax situation, investment objectives, liquidity needs, and ability to tolerate losses.
Evaluate the whole outcome
A strategy that generates substantial tax losses can still produce a disappointing investment result.
Long/short portfolios introduce borrowing and stock-borrow costs, additional fees, and the possibility of losses on short positions. Leverage can magnify losses, potentially beyond the amount initially invested. Performance may also diverge from the benchmark—a risk known as tracking error. Nuveen’s strategy risk disclosures.
There is also a distinction between deferring taxes and permanently eliminating them. Harvesting losses may reduce a current tax liability while leaving gains embedded elsewhere in the portfolio.
The useful measure is the overall result after taxes, costs, and investment performance, evaluated over an appropriate time horizon.
For someone approaching retirement or relying on sale proceeds for living expenses, liquidity and the ability to withstand losses deserve particular attention. A potential tax benefit should be weighed against the capital needed for spending, reserves, and other commitments.
Start with the decision you need to make
Before evaluating a specific strategy, clarify the financial problem.
An executive may need to reduce dependence on employer stock. A business owner may need to evaluate how sale proceeds could support retirement income. A family may want to rebalance appreciated holdings while managing taxes and maintaining capital for future goals.
Five questions can help frame the discussion:
How concentrated is my wealth? Consider investments alongside business ownership, employment income, and real estate.
What gains are likely, and when? Separate potential future gains from gains already realized.
What type of income will the transaction produce? A business or property sale can involve different tax treatments; capital losses may not offset every component. IRS Publication 544.
What risk and costs would the strategy introduce? Compare the potential tax benefit with borrowing costs, fees, liquidity needs, and possible losses.
What happens after the immediate tax need has passed? Consider how the portfolio would be managed, transitioned, or deleveraged over time, including the potential tax consequences of that transition.
These questions give your investment advisor and tax professional a common starting point. They also help keep the strategy connected to the reason you built the wealth in the first place.
Take a closer look at the strategies
Appreciated investments and major financial transactions can create new planning challenges. Addressing them thoughtfully means considering taxes, concentration, liquidity, and your next chapter together.
In a recent webinar with Auric Capital Partners and Brooklyn Investment Group, Bill Schellenberg and Erkko Etula explain direct indexing and tax-advantaged long/short strategies, discuss concentrated-stock and liquidity-event examples, and examine portfolio management and the process of reducing leverage.
Watch the full webinar for a deeper understanding of how these approaches work, their risks, and the considerations that may determine whether they fit your situation.
Registered Representative of Sanctuary Securities Inc. and Investment Advisor Representative of Sanctuary Advisors, LLC. Securities offered through Sanctuary Securities, Inc., Member FINRA, SIPC. Advisory services offered through Sanctuary Advisors, LLC., a SEC Registered Investment Adviser. Auric Capital Partners is a DBA of Sanctuary Securities, Inc. and Sanctuary Advisors, LLC.
