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We frequently have the privilege of partnering with clients who have built their wealth from a concentrated ownership position in their employer’s stock or other investment. For many, the dynamics associated with concentrated positions are complicated by both financial and emotional factors since the asset that created their wealth now represents the greatest risk to it. As with most aspects of financial planning, there is no single solution for managing concentrated positions that fits all circumstances. Rather, through an in-depth, holistic discovery process, it is important to identify a client’s short- and long-term goals, risk tolerance, income and spending trends, tax situation, philanthropic desires, liquidity needs, etc., and then advise them on the most appropriate solution for their situation. In this edition of MAInsights, we will provide a brief synopsis of the primary solutions available to manage the risk associated with concentrated stock positions and then offer our initial thoughts on opportunity zones – the most recent entrant into the world of tax sheltered investments.
Primary Solutions
While there are a number of potential solutions for mitigating the investment and tax risk associated with concentrated positions, we would group them into the following four broad strategies: to sell, to hedge, to diversify and to donate. In the following table, we outline the implementation strategies within each category and the investor goals they are designed to achieve. In each case, there are pros and cons that must be weighed to deliver the optimal solution for the client.
*Option trading may entail significant risk and is not appropriate for all investors. Diversification does not ensure profit or protect against a loss in declining market. This should not be considered a recommendation to buy or sell any security.
An Introduction to Opportunity Zones
The newest entrant into the solution set above is the Qualified Opportunity Fund, which was introduced as part of the 2017 tax reform legislation to encourage private investment in economically challenged areas (“Opportunity Zones”) across the United States. For investors who allocate to a Qualified Opportunity Fund, there are three potential tax benefits available:
Deferral of a realized capital gain
Step-up in tax basis of 10-15% if Opportunity Zone investment is held for 5-7 years
Permanent exclusion of capital gain on Opportunity Zone investment if held for 10 years
A wide range of investments can be made in a Qualified Opportunity Fund including real estate and operating companies – to date, we have seen most Opportunity Funds focus on real estate development. A successful investment in an Opportunity Zone requires an attractive underlying investment opportunity coupled with compliance to a complex set of rules and regulations. Given the unique tax and investment implications of this new structure, we are approaching it with an elevated level of scrutiny and recommend that clients work closely with their wealth manager and tax adviser before pursuing an Opportunity Zone investment. More information on Opportunity Zones including frequently asked questions can be found on the IRS website at https://www.IRS.gov.
Concluding Thoughts
Helping clients navigate the myriad of potential solutions to a concentrated stock position is just one example of the holistic guidance we strive to deliver. Partnering with our clients to mitigate their unique risks and optimize their financial future is a responsibility we value a great deal and we appreciate the confidence you have placed in us as your trusted advisor. If you have any questions or would like to discuss any changes in your financial situation, please do not hesitate to reach out to us.
Please send your questions, comments and feedback to: info@mai.capital. Any statistics mentioned have been obtained from sources we believed to be reliable, but the accuracy and completeness of the information cannot be guaranteed. Any statement non-factual in nature constitutes only current opinion of this author which is subject to change without notice. Neither the information nor any views expressed should be considered as investment advice or constitute as a recommendation to buy or sell any security, strategy or product nor should it be considered as a forecast of future events or a guarantee of future results. THIS IS NOT A RECOMMENDATION TO BUY OR SELL ANY SECURITY.
