One Way Some Wealthy Investors Can Avoid Big Capital Gains Taxes
If you are a considerably successful business owner, corporate executive, or another type of wealthy individual then you might find yourself in a dilemma when it comes to your stocks. A large part of your wealth may be tied to a particular stock and although you may want to sell/reduce your holdings, the thought of large capital gains taxes convinces you not to do so.
However, there is a potential solution, but it is not without its drawbacks. The solution is exchange funds, which have been around for decades and have an increased demand since 2013. How exchange funds works are that financial institutions, such as large banks or investment companies, establish the fund and open it for contributions to eligible investors. Each investor will make an in-kind contribution of their stock (not selling it). Once the fund reaches its target size / diversification it will close. Each investor to the fund then receives ownership interest in the fund matching the value of their original contribution. What makes the transfer of a stock to an exchange fund different from other stock transactions is that it does not trigger capital gains taxes.
If an investor were to leave an exchange fund they would receive a collection of individual stocks rather than a cash distribution. One should also note than an exchange fun can only hold 80% of its assets in stocks or other marketable securities, the remaining 20% must be in illiquid investments. There are also holding period requirements. It is worth knowing that exchange funds do serve as perfectly legal tax shelters and as a way for wealthy individuals to defer large capital gains taxes for longer periods of times.