The 38% Position
Grace Whitfield, 63, is a widow. Her $6.3 million portfolio includes $2.4 million of stock in the company her late husband founded, with a cost basis of $210,000. She also holds $1.1 million in an IRA, $900,000 in a diversified taxable account, and $1.9 million in rental real estate and her home. Her combined long-term capital gains rate is 28.8% (20% federal, 5% state, 3.8% net investment income tax). She gives $30,000 a year to her church and wants to give more. She wants the single stock down to 5% of the portfolio within three years but refuses to pay 'a million dollars in tax for nothing.' She plans to leave everything to two children, ages 34 and 31, and says the stock 'has always come back.'
1. Quantify the cost of selling and the cost of not selling, and frame the choice so the client can actually make it.
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The certain number.
Gain = $2,400,000 - $210,000 = $2,190,000. Tax at 28.8% = $630,720. Net proceeds $1,769,280. That is 26.3% of the position - and it is a certain, one-time, known cost.
The uncertain number.
Assume the shares carry 32% annual volatility, roughly double a diversified index, with no expected return advantage - idiosyncratic risk is uncompensated. On those assumptions the probability that the position is worth 40% less in three years is roughly one in four, and the odds of touching that level at some point in the window are higher. A 40% decline is $960,000 - about $330,000 more than the entire tax bill - and unlike the tax, it is not recoverable by anything.
The reframe that usually works.
"If you inherited $2.4 million of cash tomorrow, would you buy this one stock with 38% of your portfolio?" The answer is always no, and the reason is never the tax rate - it is that she would never concentrate that much in a single name from scratch.
Then separate the asset from the husband. The stock is the last living piece of the company he built, and selling it feels like a second loss. Name that explicitly. It changes the negotiation from 'how much tax' to 'what does the money need to do for you and the children.'
Finally, note that at 5% of a $6.3 million portfolio the retained position is roughly $315,000 - enough to keep the certificate, the annual meeting, and the story, while removing the risk that actually threatens the plan.
2. Design the three-year transition. Specify the tactics, the sequencing, and which specific shares go where.
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Three buckets, three different rules.
- Charity (the cheapest shares to move). Gift the low-basis shares instead of cash. On a $30,000 gift she deducts $30,000 of fair market value and avoids 28.8% on the 91% of the gift that is gain - a swing of about $7,900 a year versus writing a check. If she has a high-income year, front-load five years ($150,000) into a donor-advised fund and take the deduction at once.
- Diversify (the bulk). Sell in scheduled quarterly tranches of roughly $250,000-$300,000 rather than in one trade, over the three-year window. If she is a board member or trustee, all sales go through a pre-set plan and clear the company's windows. Consider an exchange fund for $400,000-$600,000: it defers the gain and removes single-stock risk but leaves full market risk, locks the money for about seven years, and carries fees - use it only for the slice she will not need.
- Hold (the 5%). Retain roughly $315,000. Document that this is an emotional and legacy allocation with a stated dollar cap, and re-test it annually.
What never gets done: low-basis shares are not gifted to the children. Carryover basis means the children inherit her $210,000 basis and the gain. Low-basis stock is the asset she dies with (step-up) or gives to charity. If she wants to make lifetime gifts to the children, use cash or the high-basis lots in the diversified account.
Hedging: a collar or prepaid variable forward can cap the downside, but they are costly, counterparty-dependent, and certain structures are treated as a deemed sale. Never present a hedge as a substitute for diversification.
3. She asks: 'Why not just hold it until I die? My kids get the step-up and the tax disappears.' Give the strongest version of her argument, then say what has to be true for it to win.
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The strongest version of her case.
At equal expected returns, deferral is nearly free money: the $630,720 of tax not paid today compounds for her benefit, and at death the step-up eliminates the gain on everything still held. Her spending is covered by the rentals and the IRA, so she is never a forced seller. And the position is 38% of the portfolio, not 38% of her net worth - she has $3.9 million of other assets. A quick check: if the stock compounds at 8% for ten years, the deferred tax bill grows to about $1.43 million, but the after-tax value of holding still edges out selling now and reinvesting at the same return. On pure arithmetic, with equal returns, she is approximately right.
What has to be true for that to win:
- The return assumption has to be right. The comparison assumes the single stock earns exactly what the diversified portfolio earns. If it underperforms by even 1% a year - the base case for an uncompensated concentrated position - the deferral advantage is gone within the decade, and the tax saving can never be recovered.
- No drawdown she cannot tolerate. A 40% decline costs $960,000, more than the entire tax bill, and the step-up only helps the value that survives.
- Time horizon, not immortality. The step-up arrives at her death; the risk is borne every day until then, possibly 25-30 years.
- The law holds. Step-up is a policy choice, not a law of nature, and a portfolio concentrated for a tax rule is a concentrated portfolio.
Conclusion: split the difference and say so out loud. Keep 5%-10% for the step-up and the legacy, diversify the rest. Partial diversification captures most of the risk reduction; total inaction bets the plan on a tax provision and a single company.