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Exchange Fund Strategies


Tax Strategies for Low Cost-Basis Stock Sales
When a single stock constitutes a large percentage of your net worth, diversifying your holdings may seem like a formidable task, especially if you are concerned about incurring large capital gains taxes. Fortunately, many strategies exist to help you reduce the risk involved in a single-stock position, create liquidity, or achieve diversification. The most appropriate course of action will depend on your personal objectives, your cash flow needs, your long-term view about your stock, and any restrictions on your shares.

Exchange Funds
An exchange fund is a private investment fund that offers you a way to dispose of a low-basis stock and diversify your portfolio without immediately incurring capital gains tax liability. To diversify your investment portfolio, you can contribute stock on a tax-free basis and receive an interest in a limited partnership known as the exchange fund. An exchange fund is similar to a diversified mutual fund, in that many participants contribute assets to the partnership and receive in return a pro-rata share of the partnership assets and any distributions.
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How They Work
In an exchange fund, cash contributions are usually not required. Instead, a professional fund manager selects and screens the securities contributed by each investor in an effort to make the fund match or outperform a given benchmark, such as the S&P 500 Index.

After formation, most exchange funds are passively managed, much like index portfolios. Generally, the structure requires you to keep your stock within the partnership for at least seven years to take full advantage of the tax-deferral benefits.

Some exchange funds allow you to redeem your shares before seven years; however, you will pay fees for an early redemption and not realize the tax-deferral benefits. When the fund is terminated, or if you redeem your shares after seven years, you will receive a diversified portfolio reflecting your stock and the stock contributed by all other investors. If properly anticipated, the distributed set of securities may be integrated into your existing public equity portfolio so that capital gains taxes may be deferred indefinitely.

The primary benefit of exchange funds is they permit you, over time, to exchange a concentrated single-stock position for a diversified basket of securities. Besides diversification and tax-deferral benefits, other advantages of exchange funds are that they can accept restricted stock and may not require SEC Form 144 disclosure for affiliates.

On the downside, most exchange funds have seven-year holding requirements. You have little or no input into the specific securities an exchange fund holds or when it disposes of those assets. If you redeem your interest in the fund before the required holding period, you incur an immediate tax liability on the securities received in distribution unless they are identical to what you contributed.

Some exchange funds also suffer from poor performance and do not effectively track the indexes they are seeking to mimic. These offerings can also carry fairly hefty sales loads and management fees, making them more expensive products than other diversification options.

For more information:
If you'd like more information about how diversified investment advisors can help you achieve your financial objectives through personalized wealth or retirement and risk management strategies, please contact us. We welcome the opportunity to discuss your unique needs and how we may best meet them.

This page (formatted for versions 10.0 and higher of Internet Explorer) is updated regularly so check in from time-to-time to see new articles and updates. You can click on any underlined words on each page to see a specific wealth management topic in the left margin of each page.

Charles M. Bloom, Registered Principal offers securities and advisory services through Centaurus Financial, Inc. - Member FINRA and SIPC - 775 Avenida Pequena, CA, 93111 (mailing address: 3905 State Street Suite 7173, Santa Barbara, CA, 93105) - CA Life Insurance License No. 0A52786 - Centaurus Financial, Inc. and Shoreline Wealth & Investment Management are not affiliated companies.

The information contained in this web site is neither an offer nor solicitation of any security or service.


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