What to do with Capital Gains Before Year-End

Patrick R. Cote CFA, CFP® |

Many investors will have the happy problem of unrealized capital gains in 2025. If these gains are in a taxable brokerage account and have been held for more than a year, if the securities are sold, they would incur a long-term capital gains tax in the range of 0% - 38%, depending on the investors’ income level and state of residency (when including the 3.8% NIIT, or net investment income tax). Households earning $250K - $600K would generally pay the federal rate of 18.8% in addition to their state tax, while households earning >$600K would pay a federal rate of 23.8% in addition to the applicable state tax.

If the investments with unrealized capital gains continue to make sense for the investor, say an S&P 500 ETF (exchange-traded fund) like IVV, it would typically make sense to continue to hold the positions for the long-term. However, what should an investor do if they have a heavily concentrated position and are not comfortable with the associated risk? For example, someone who bought Nvidia a while back might now find that it represents a large part of their portfolio. If they are looking to reduce their exposure to Nvidia, rather than selling and incurring the capital gains tax, there are five potential alternatives:

  1. Exchange funds – only available for qualified purchasers (investors with >$5 million in investments) - typically used for a single stock that has large unrealized gains. Note that investors must apply to join the exchange fund (which might be tough with Magnificent 7 stocks) and the investments will be locked up, typically for seven years. An investor’s stock position is replaced with a position in an exchange fund without incurring any capital gains tax.
  2. Section 351 exchange – a relatively new interpretation of a tax-deferral technique that involves replacing an investor’s stock position with a position in a special fund. This has been recently applied to ETFs – typically used for a single stock that has large unrealized gains. Like the exchange fund, the stock position is replaced with a similarly valued position in the fund. Note that Section 351 exchanges are complex and have only recently been used in this manner, so many investors may not be comfortable with this approach.
  3. CRT (charitable remainder trust) – contribute any appreciated assets to receive a partial deduction, with the donor receiving taxable payouts and the remainder eventually going to charity. Can be for a single stock or even well-diversified funds, like IVV or FXAIX, with large unrealized gains.
  4. Direct indexing – build the rest of a well-diversified portfolio around positions with unrealized gains. This approach works well if the investor has a significant amount of cash to invest in the near term. Can be for a single stock or even multiple positions with large unrealized gains that are concentrated in specific sectors (like technology).
  5. Donor-advised funds 5.– contribute appreciated assets and receive a tax deduction for the fair market value. Can be for a single stock or even well-diversified funds with large unrealized gains.

All of the above techniques can help to reduce taxes for investors with large unrealized gains in their portfolio and can also help to reduce the exposure to a concentrated position in a portfolio. However, they can be complex to execute, so investors should work with an experienced investment advisor and tax professional to make sure they are done correctly. Please feel free to reach out to us if you have any questions.