How to Unwind Concentrated Stock and Real Estate Positions Without Getting Crushed by Taxes

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The biggest trap in wealth building isn't risk or volatility. It's inertia. Clients with concentrated stock positions and appreciated rental property often sit frozen, watching their portfolios tilt dangerously toward a single asset because selling means handing over 30 to 40 percent to state and federal tax authorities. The good news is that a set of tested, legal strategies exists to diversify concentrated positions and exit underperforming real estate while deferring or even eliminating the tax bill. These tools work particularly well for early career professionals, entrepreneurs, and accredited investors in Austin and beyond who value transparency, smart planning, and flat fee advice over commission driven product pushing.

Why Concentrated Positions and Real Estate Create Hidden Risk

Holding more than 10 to 20 percent of total investable assets in a single stock exposes clients to material company specific risk. When employer stock comes from restricted stock units, incentive stock options, or employee stock purchase plans, the combination of career income and portfolio returns rides on one entity's performance. A sudden earnings miss, regulatory action, or management shakeup can wipe out years of wealth accumulation in weeks. Real estate concentration carries similar danger. A single rental property or small portfolio of inherited houses ties up equity in illiquid assets that demand active management, expose owners to tenant disputes and maintenance headaches, and concentrate geographic and sector risk in one corner of the market.​

The tax obstacle is formidable. Federal long term capital gains rates for 2025 range from zero percent for single filers earning up to 48,350 dollars to 15 percent for those earning between 48,351 and 533,400 dollars, and 20 percent for income above 533,400 dollars. High earners also face the 3.8 percent Net Investment Income Tax when modified adjusted gross income exceeds 200,000 dollars for individuals or 250,000 dollars for married couples filing jointly. State taxes add another layer. California imposes up to 12.3 percent, New Jersey up to 10.75 percent, and even Texas residents with out of state property may owe tax to the jurisdiction where the asset is located. For a client in California with a million dollar gain, the combined federal and state tax bill can exceed 400,000 dollars, reducing the amount available for reinvestment by nearly half.​

Real estate investors face depreciation recapture on top of capital gains. When a rental property is sold, the IRS requires owners to recapture previously claimed depreciation deductions at a federal rate of 25 percent under Section 1250. If the property was cost segregated to accelerate depreciation on personal property components like appliances and fixtures, those amounts are recaptured as ordinary income under Section 1245, which can push the effective rate even higher. A property purchased for 500,000 dollars with 150,000 dollars of accumulated depreciation and sold for 800,000 dollars generates a 450,000 dollar gain, with 150,000 dollars subject to recapture and the remainder taxed as long term capital gains. Paying that bill upfront drastically reduces the capital available for diversification.​

Delaware Statutory Trusts and 1031 Exchanges for Real Estate

A 1031 exchange allows real estate investors to defer capital gains taxes and depreciation recapture by selling an investment property and reinvesting the proceeds into another like kind property. The IRS imposes strict timelines. Sellers have 45 days from the close of the relinquished property to identify up to three potential replacement properties, and 180 days to complete the purchase. All net proceeds must be held by a qualified intermediary, and the replacement property must be equal or greater in value, with all equity reinvested and any debt replaced by new debt or additional cash. When executed correctly, both capital gains and depreciation recapture are deferred, and the accumulated depreciation carries over into the replacement property's adjusted basis.​

The challenge is finding suitable replacement property within the 45 day window and avoiding the ongoing landlord responsibilities that many investors want to escape. Delaware Statutory Trusts solve both problems. A DST is a legal entity that holds title to institutional grade real estate and allows multiple investors to purchase fractional beneficial interests. The IRS ruled in Revenue Ruling 2004-86 that DST interests qualify as like kind property for 1031 purposes. DST sponsors maintain a pipeline of pre packaged properties, so investors can immediately identify and close on a replacement investment without scrambling to find individual properties or negotiate with sellers.​

DSTs offer passive ownership. Professional management companies handle tenant relations, property maintenance, and lease negotiations. Investors receive quarterly distributions from master lease arrangements, typically yielding 4 to 4.3 percent, without dealing with toilets, tenants, or tax filings beyond a 1099. Minimum investments are often as low as 10,000 to 25,000 dollars, allowing clients to diversify across multiple properties and asset classes rather than concentrating in a single replacement property. For clients in their 70s who inherited rental homes and want to hang out with grandchildren instead of changing light bulbs, DSTs provide a path to liquidity and income without triggering a tax event.​​

One key consideration is the composition of the DST investor base. Blackstone's real estate troubles in recent years stemmed partly from co mingling retail investors with large Chinese institutional investors who pulled capital during China's real estate crisis, forcing fire sales and redemption gates. Advisors should ask DST sponsors what percentage of the fund is represented by single purchasers over one million dollars and walk away if that concentration exceeds 30 percent. Sponsors like Hines, which maintains an average ticket of 80,000 dollars and weathered multiple market cycles without gating, offer greater stability.​

The 721 UPREIT Path to Permanent Diversification

A 721 exchange, also called an UPREIT transaction, allows real estate owners to contribute property to a real estate investment trust's operating partnership in exchange for operating partnership units, deferring capital gains under Section 721 of the Internal Revenue Code. For most individual investors, the path involves a two step process. First, complete a 1031 exchange into a DST. Then, after the DST satisfies the IRS investment intent requirement, typically two years, the DST is contributed to a REIT via a 721 exchange, and DST interests convert into OP units. The investor now holds a diversified portfolio of institutional real estate across 100 or more properties, with professional management and no landlord duties.​​

OP units can later be converted into publicly traded REIT shares, at which point the previously deferred gains are recognized. However, if the investor holds the OP units until death, the beneficiaries receive a step up in basis to fair market value, eliminating the deferred capital gains and depreciation recapture entirely. This makes the 721 UPREIT strategy especially valuable for estate planning. Beneficiaries inherit liquid, easily divisible REIT shares with no tax liability, and each heir can independently decide whether to liquidate or hold for income.​

The tradeoff is that once DST interests are converted into OP units, the ability to do another 1031 exchange is lost. Traditional DST sales allow investors to roll into a new property and continue deferring taxes, or to pay the tax and use the funds for other purposes, preserving flexibility. Optional 721 DSTs give investors the choice at the time of liquidity. If the investor opts not to contribute to the REIT, they can still do a 1031 exchange into another property. If they choose the UPREIT path, they accept the loss of 1031 flexibility in exchange for diversification, professional management, and estate planning advantages. The decision should be made based on the client's tax situation, liquidity needs, and long term objectives at the time of the DST sale.​

Exchange Funds for Concentrated Stock Positions

Exchange funds allow investors to contribute concentrated stock positions into a pooled partnership and receive a diversified portfolio in return without triggering immediate capital gains. The transaction works through an in kind contribution. Investors transfer their appreciated shares directly to the fund, and in exchange receive a proportional share of the overall fund, which holds a basket of stocks contributed by multiple participants. Since no sale occurs, no capital gain is realized at the time of contribution. The investor's original cost basis and holding period carry over to the exchange fund units, preserving long term capital gains treatment.​

Most exchange funds require a seven year holding period. After the lockup, investors receive a pro rata distribution of diversified securities, typically delivered in kind, which can be held or sold at that time. Capital gains taxes are deferred until the investor sells the distributed shares. The tax deferral advantage is significant. A client with two million dollars in company stock purchased for 200,000 dollars faces roughly 432,000 dollars in federal capital gains tax at a 24 percent rate if they sell outright, leaving 1.368 million dollars to reinvest. By contributing to an exchange fund, the entire two million dollars is diversified immediately. Over 10 years at seven percent annual returns, the exchange fund grows to 3.93 million dollars, compared with 2.69 million dollars if only the after tax proceeds were invested, a difference of 1.24 million dollars before eventual taxes.​

Exchange funds are restricted to accredited investors, defined as individuals with net worth over one million dollars excluding primary residence, or annual income over 200,000 dollars individually or 300,000 dollars jointly for the past two years with reasonable expectation of the same in the current year. Financial professionals holding Series 7, Series 65, or Series 82 licenses in good standing also qualify. Minimum investments typically range from 250,000 dollars to one million dollars depending on the fund. The strategy works best when the concentrated position exceeds 10 to 20 percent of net worth and the investor has substantial unrealized capital gains.​

The primary downside is illiquidity during the seven year holding period. Investors cannot access the contributed value until the lockup expires, so liquidity planning is essential. Exchange funds also involve management fees, typically structured as an annual management fee rather than an upfront load, though the fee schedules can be complicated and vary by fund. Advisors should carefully review the fee structure and ensure clients have adequate liquid reserves outside the exchange fund to cover living expenses and emergencies.​​

Section 351 ETF Exchanges for Diversified Portfolios

Section 351 of the Internal Revenue Code allows investors to contribute appreciated securities to a newly formed exchange traded fund in exchange for ETF shares without triggering capital gains, as long as certain diversification tests are met. The transaction pools portfolios from multiple investors in a newly created ETF, with investors receiving ETF shares in return for the assets they contributed. If the exchange meets Section 351 requirements, it is tax deferred, and the investor's original cost basis and holding period carry over to the ETF shares.​

The key restriction is the 25 50 diversification test under Section 368. To qualify, no single asset in the contributed portfolio can exceed 25 percent of the portfolio's value, and the top five holdings cannot exceed 50 percent of the overall value. The test is applied on a look through basis for ETFs, so a portfolio consisting of S&P 500 index ETF shares would be treated as an agglomeration of 500 individual companies, not as a single asset, making it much easier to pass the diversification requirements. However, mutual funds, alternative assets, and REITs are generally not eligible for Section 351 exchanges.​

Once inside the ETF wrapper, assets can be reallocated with minimal tax impact through the ETF's in kind creation and redemption process, which qualifies for tax free treatment under Section 852. This allows the fund manager to rebalance and adjust holdings without triggering capital gains distributions to shareholders. Investors effectively convert a locked up portfolio into a diversified, tax efficient vehicle that can be managed with little or no ongoing tax drag. The tax on embedded gains is deferred until the investor sells the ETF shares, donates them to charity to avoid capital gains taxes altogether, or holds them until death to receive a step up in basis.​

Section 351 exchanges require participation in the seeding of a new ETF, meaning investors must work with an ETF sponsor willing to accept in kind contributions. The contributed assets must collectively represent at least 80 percent of the new ETF's shares immediately after the exchange to qualify for tax deferral under Section 351. If the exchange fails to meet the diversification test or the 80 percent ownership requirement, the IRS may deem the transfer taxable, and the investor would recognize any embedded capital gains. Proper analysis and verification by tax counsel is critical to avoid an unexpected tax bill.​

Hedging Strategies for Partial Liquidity

Clients who need liquidity but want to defer taxes can use options strategies to monetize a portion of their concentrated stock position without selling. A cashless collar combines buying a protective put and selling a covered call on the underlying stock. The put gives the investor the right to sell the stock at a predetermined strike price, capping downside losses, while the call obligates the investor to sell the stock at a higher strike price if it rises, capping upside gains. The premium received from selling the call offsets the cost of the put, making the strategy cash neutral or even generating a credit.​

For example, a client holding 1,000 shares of stock at 150 dollars per share, with a low cost basis, can buy 10 put contracts with a 140 dollar strike for five dollars each, costing 5,000 dollars total, and simultaneously sell 10 call contracts with a 160 dollar strike for five dollars each, receiving 5,000 dollars in premium. This creates a zero cost collar. If the stock drops to 130 dollars, the investor exercises the puts to sell at 140 dollars, limiting the loss to 10 dollars per share. If the stock rises to 170 dollars, the calls are exercised and the investor sells at 160 dollars, gaining 10 dollars per share. If the stock stays at 150 dollars, both options expire worthless and the investor retains the stock unchanged.​

The collar protects against downside volatility without triggering an immediate capital gains tax, making it especially valuable for low basis stock from restricted stock units or employee compensation. The investor retains ownership, dividends, and voting rights during the collar period. The collar also enhances the ability to borrow using the underlying stock as collateral, allowing the investor to access liquidity without selling. However, creation of a collar may be a disclosable event and could be prohibited for corporate insiders by the company's insider trading policy, so compliance review is essential.​

Qualified Opportunity Zones for Partial Deferral

Qualified opportunity zone investments allow investors to defer capital gains by reinvesting eligible gains into a qualified opportunity fund within 180 days of the sale. The deferral lasts until the earlier of December 31, 2026, or the date the QOF investment is sold. Investors who held QOF investments for at least five years before December 31, 2021, received a 10 percent exclusion of the deferred gain, and those who held for seven years received an additional five percent exclusion, though those benefits have now expired.​

The most valuable benefit is the permanent exclusion of future gains. If the QOF investment is held for at least 10 years, the investor can elect to step up the basis of the QOF investment to fair market value, permanently excluding any appreciation in the opportunity zone investment from taxation. This essentially amounts to an interest free loan from the federal government on the deferred gain and a complete tax forgiveness on the new gain. For taxpayers with eligible gains from 2024 or early 2025, investing into a QOF still provides nearly two full years of deferral and the permanent exclusion of future gains if held for 10 years.​

QOFs must invest at least 90 percent of their assets in qualified opportunity zone property, which includes tangible property acquired after December 31, 2017, where original use begins with the fund or the property is substantially improved. Qualified opportunity zones are designated low income census tracts with either a poverty rate of at least 20 percent or median family income below 80 percent of the area median. The strategy works best for clients with large capital gains who are willing to hold the investment for a decade and who are comfortable with the economic risk and social impact of investing in distressed communities.​

Conclusion

Concentrated stock and real estate positions create significant risk and tax friction, but a range of strategies exists to diversify and unwind these holdings while deferring or eliminating the tax bill. Delaware Statutory Trusts and 1031 exchanges allow real estate investors to exit active management and defer capital gains and depreciation recapture. The 721 UPREIT path converts DST interests into diversified REIT ownership and enables a step up in basis at death. Exchange funds and Section 351 ETF exchanges provide tax deferred diversification for concentrated stock positions. Cashless collars offer downside protection and liquidity without triggering an immediate sale. Qualified opportunity zone funds defer gains and exclude future appreciation if held for 10 years. Each strategy has specific requirements, limitations, and tradeoffs, and proper execution requires coordination with tax counsel, qualified intermediaries, and experienced advisors. For clients willing to plan ahead, these tools transform inertia into action and convert concentrated risk into diversified, tax efficient wealth.