How to Diversify Concentrated Stock Without Triggering a Massive Capital Gains Tax Bill

Why concentrated stock is a risk worth solving

At Wealthstone, prospective clients often come to us with the same issue, especially those near our San Ramon office and across Silicon Valley, Palo Alto and the rest of the Bay Area. They have millions of dollars of company stock. It now makes up a huge part of their net worth. And they know they’re sitting on a potential disaster.

That one asset drives most of their financial and retirement dreams, and at any moment it could fall victim to what many stocks historically have. Some companies go out of business. The more likely outcome is that business cycles shift, the stock price drops significantly, and we’re forced to re-evaluate retirement spending and plans, or delay retirement entirely. For many investors sitting on large concentrated positions, it shows up as anxiety, stress and lost sleep.

They want to eliminate or reduce this risk. But they also know that if they sell, they could pay many millions in taxes and permanently lose a portion of their net worth. In California, which taxes capital gains as ordinary income at rates up to 13.3%, a large sale can face a combined federal and state rate of roughly 37.1%: 20% federal, 3.8% net investment income tax, and 13.3% state.

After meeting investors with this very issue over and over again, I began to research the tax and investment strategies that allow investors to reduce their risk and their concentrated stock exposure while reducing, deferring or eliminating the capital gains taxes associated with selling their company stock. That research eventually became my book, Secrets From a Wealth Advisor: 4-Stage Methodology For Diversifying Concentrated Stock Tax Efficiently.

The key takeaway is that with the right amount of planning, you could potentially diversify without paying the capital gains tax a straight sale would create. Many of these strategies are only available to investors who meet certain net worth or investment minimums, so the first step is always determining which ones your situation actually qualifies for.

Four strategies to diversify without a massive tax bill

Strategy 1: Tax-Aware Long/Short Strategies

A tax-aware long/short strategy holds a diversified long portfolio alongside a smaller short portfolio, in ratios such as 130/30 and higher. Because the manager is trading both sides continuously, the portfolio can realize capital losses throughout the year, even in years when the account itself is growing. Those losses can then be used to offset the gains you realize as you sell down your concentrated stock. Many of these accounts can be funded in kind, meaning you contribute the shares themselves rather than selling them first.

Here’s what that can look like. Consider a hypothetical investor who funds a $4 million account with concentrated stock. Over the course of a year, the account could grow in value while the manager harvests more than $1 million of capital losses, losses the investor can then use to sell more of the concentrated position without the usual tax bill. This is an illustration of how the strategy works, not a typical or guaranteed result. This is also an example of how using the correct advisor team can lead to both growth in your account and tax losses captured through portfolio management.

The trade-off: these strategies use shorting and leverage, carry higher fees than a simple index fund, and are generally limited to accredited or qualified investors. The amount of losses harvested varies from year to year and depends heavily on markets and the manager.

Strategy 2: Qualified Opportunity Zone (QOZ 2.0) Funds

The mechanism is simpler than most people expect. The client sells stock, then within 180 days contributes only the capital gains portion to a Qualified Opportunity Fund. Under the One Big Beautiful Bill Act, gains invested after December 31, 2026 are deferred for five years from the date of the investment, so a gain invested in 2027 isn’t recognized for tax purposes until 2032, and one invested in 2028 not until 2033. Hold the fund for five years and 10% of the deferred gain is excluded (30% for qualified rural funds). Hold it for at least 10 years, and the appreciation on the fund investment itself can be tax-free.

Now it begs the question: what do we do with the cost basis portion? We would take those funds and look at investing them in strategies such as the long/short funds above, so the basis keeps working while the gain is deferred.

The trade-off: Opportunity Zone funds are illiquid, long-term investments, usually in real estate or operating businesses inside designated zones, and their value can fall. The deferred gain still comes due at year five, so you need liquidity set aside to pay it. Timing also matters right now. Gains invested on or before December 31, 2026 fall under the old rules, which end the deferral at the end of 2026 with no step-up, so for a sale late this year, when the money goes in can matter as much as whether it goes in.

Strategy 3: Exchange Funds

We would explore ways to exchange a portion of the client’s concentrated stock position for a share of a diversified basket of stocks. An exchange fund is a partnership that pools shares contributed by many investors, each bringing a different stock. Under Section 721 of the tax code, contributing stock to a partnership generally isn’t a taxable sale, so this allows us to immediately reduce single-stock risk without a tax bill. After the holding period, typically seven years, investors can redeem in kind and walk away with a diversified portfolio.

The trade-off: your original cost basis carries over to what you receive, so the gain is deferred, not eliminated. To keep its tax treatment, the fund must hold at least 20% of its assets in illiquid holdings such as real estate. Leaving early usually means getting your own shares back. Most exchange funds also require qualified purchaser status, generally $5 million in investments, and they only accept the stocks they need for diversification, so not every position qualifies.

Strategy 4: Options-Based Hedging

Options can reduce the risk in a concentrated position without selling it. A common structure is a collar: buying a put option to set a floor under the stock and selling a call option to help pay for it. For employees, the first step is reviewing the company’s rules and coordinating with its human resources or stock plan team, because many public companies restrict or prohibit hedging by employees, officers and directors. If the client is no longer employed by the company, or never was, we would certainly look at using options hedges to reduce risk.

The trade-off: hedges have to be designed around the tax code. If a hedge removes too much of both the upside and the downside, the IRS can treat it as a constructive sale under Section 1259, triggering the very tax you were trying to avoid. Collars are also generally subject to the straddle rules, which can defer losses on the option positions. Structured correctly, options can protect the position while the longer-term diversification plan plays out.

What this means for your plan

These are just a few of the strategies Wealthstone advisors review and deploy for clients when suitable. Used together, they allow us to take a concentrated stock position, immediately reduce risk, and engineer long-term investment strategies that aim to reduce or eliminate the capital gains taxes associated with ultimately diversifying it.

Alternatively, a client could hold their concentrated stock position until death and receive a step-up in basis, which can erase the embedded gain for their heirs. The two main risks associated with doing so: first, we’re hoping the underlying stock doesn’t go to zero or crash significantly before then, in which case it would have been better to just pay the tax. Second, we’re hoping the step-up in basis rule doesn’t get eliminated, and proposals to limit it have surfaced before.

I always say, “hope is not a strategy.” Everything starts with a plan. At Wealthstone, we have the experience of helping clients plan the diversification of concentrated stock positions, with the goal of achieving less risk in their portfolios while reducing or eliminating their capital gains taxes.

Our tax knowledge also lets us look past capital gains to the rest of a client’s tax picture: reducing ordinary income taxes, and managing the taxes associated with executing Roth conversions. For clients with $10 million or more in net worth, the potential savings worth analyzing across all of these areas can be substantial. Clients often ask about the fees associated with hiring Wealthstone and the costs of these strategies. We disclose all of them up front, and we show the analysis side by side so the client can judge whether the after-tax benefit justifies the cost.

A point about managers: it’s very important to work with a firm that has deep industry relationships with the hedge funds and asset managers that run these strategies, because many of them aren’t available through a typical brokerage account. Wealthstone has built those relationships across the industry and pairs that access with years of hands-on experience implementing these strategies. I wrote a book on this very topic, and I’ve advised the heads of equity compensation plans at publicly traded companies on these strategies, as well as employees at many of the world’s largest companies.

Next steps

1. Schedule an initial consultation with Wealthstone, virtually or in person at our San Ramon or Scottsdale office. In-person meetings are by appointment only.
2. Prefer to start by email? Write to zak@wealthstonepwm.com to discuss your situation.
3. Before the meeting, gather your brokerage and stock plan account statements (including cost basis by lot and any vesting schedules), your last two years of tax returns, and the spreadsheet or tool you use to track your total net worth.

About Wealthstone

Wealthstone Private Wealth Management is an independent, fiduciary registered investment adviser focused on three planning disciplines: concentrated stock, high-net-worth retirement, and business owner exit planning.

In-person meetings are by appointment only. Schedule an initial consultation, or email zak@wealthstonepwm.com.

Zak Gardezy, CFP®

Zak Gardezy is the Founder & Managing Partner of Wealthstone Private Wealth Management and the author of Secrets From a Wealth Advisor: 4-Stage Methodology For Diversifying Concentrated Stock Tax Efficiently. He advises executives and employees of publicly traded companies on equity compensation and tax-aware diversification.

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