CFA CFA level 3 CFA level 3 CFA level 3 CFA level 3 CFA volume 2 finquiz curriculum note, study session 5, reading 11

Concentrated Single-Asset Positions
1.

INTRODUCTION

A concentrated position occurs when an investor owns
an asset that represents a large percentage of his/her
overall portfolio or net worth. Concentrated position in
an investor’s portfolio reduces portfolio diversification
and exposes the investor to significant idiosyncratic (or
company-specific) risk and sector-specific risk. In
addition, sale of a concentrated position may raise
substantial concerns about tax and liquidity.
2.

The objective of managing a concentrated position is to
hedge the investor’s portfolio against price declines and
diversify it in a tax-effective manner. In order to best
meet this objective, the investor must match his goals
and objectives with different hedging tools and
techniques by considering the benefits and drawbacks
of each tool/technique.

CONCENTRATED SINGLE-ASSET POSITIONS: OVERVIEW

The three major types of “concentrated position in a
single asset” include:
1) Publicly traded single-stock positions: Concentrated
positions in publicly traded single-stock may occur as
a result of
• Stock or stock options received by senior company

executives as part of their compensation;
• A large position in a single stock inherited by family
members;
• Stock received by the seller of a privately owned
business in lieu of cash when the buyer is a publicly
traded company;
• A successful long-term buy-and-hold investing
strategy;
• An IPO of a private company;
• A heavy allocation of a pension fund in a sponsor’s
company stock;
• A significant amount of shares of another publicly
traded company held by a publicly traded
company for business or investment purposes.
2) A privately owned business (including family-owned
businesses): It refers to ownership in privately owned
businesses that is transferred down from one
generation to the next.
3) Commercial or investment real estate: Concentrated
positions in investment real estate can be derived as
a result of
• A significant percentage of the value of a private
business enterprise represented by commercial or
industrial real estate;
• A standalone investment of private clients (i.e. real
estate developers) in commercial real estate;
• Inheriting investment real estate or receiving a gift or
bequest;
• Lack of other investment opportunities in certain
jurisdictions;

2.1

Investment Risks of Concentrated Positions

The concentrated positions in a single asset expose an
investor to systematic risk and non-systematic risk (either
company or property-specific risk). Besides risk,
concentrated positions also affect return of an investor
because holding under-performing company stock or
non-income-producing land involve greater opportunity
costs and some concentrated positions may not
generate fair risk-adjusted returns.
Concentrated positions cause owners to underestimate
the risk of their concentrated position and significantly
overestimate the value of that asset.
2.1.1) Systematic Risk
Systematic risk/non-diversifiable/market risk is the risk that
affects the entire market or economy and cannot be
reduced through diversification. For example, risk
associated with interest rates, inflation, economic cycles
etc.
Different sources of systematic risk include:
• Equity market risk
• Business cycle risk (i.e. risk associated with
unexpected changes in the level of real business
activity)
• Inflation risk (i.e. risk associated with unexpected
changes in inflation rate) etc.
Note that when the risk of human capital is the same as

the systematic risk exposures associated with a
concentrated position (e.g. founder of a securities firm
with a concentrated position in the firm’s shares), then
the investor would face portfolio losses and decrease in
job earnings at the same time.
2.1.2) Company-Specific Risk
Company-specific risk is the risk that affects a single
company or industry. It is also known as non-systematic
risk, industry specific or idiosyncratic risk e.g. failure of a
drug trial. A concentrated position in a single stock
exposes an investor to a higher level of company-

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Reading 11


Reading 11

Concentrated Single-Asset Positions

specific risk. The level of company-specific risk is
positively related to volatility of returns, all else equal.
Company-specific risk can be reduced or avoided
through diversification i.e. investing in different asset
classes and/or securities.
2.1.3) Property-Specific Risk

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• A potential environment liability associated with a
particular property;
• Risk associated with renewal of leases and time
period involved in finding new tenants;
• Credit risk associated with smaller, non-investmentgrade tenants;

Property-specific risk is a type of non-systematic risk that
affects a particular piece of real estate. For example,
3.

3.1

GENERAL PRINCIPLES OF MANAGING CONCENTRATED SINGLEASSET POSITIONS

Objectives in Dealing with Concentrated
Positions (covering Section 3.1.1-3.1.2)

1) Typical Objectives: Typical objectives include goal
• To reduce the concentration risk while minimizing
any costs associated with risk reduction.
• To generate liquidity in order to diversify and to
satisfy spending needs.
• To optimize tax-efficiency, that is, to achieve the
above two objectives in the most tax-efficient
manner.
2) Client Objectives and Concerns: The concentrated
position can be used in conjunction with gifting
strategies to meet wealth transfer objectives i.e.

leaving a bequest or giving charity etc.

other key employees the opportunity to eventually
acquire control of the business;
• May wish to transfer control of the business to the
next generation;
Rationale for holding concentrated positions in
investment real estate: The investor may prefer to retain
concentrated positions in real estate
• To maintain control of the property for the successful
operation of a business enterprise;
• To transfer ownership of the real estate to the next
generation;
• To generate profit through price appreciation of the
property;
3.2

In managing risks of concentrated positions, advisors
must also consider rationale for holding such positions.
Rationale for holding concentrated stock positions: An
investor may prefer to retain concentrated stock
positions because of
• Selling constraints imposed on company executives
to hold shares for a long time period in an attempt to
encourage them to work hard for the growth of the
company;
• Emotional attachment to the stock.
• Concerns about the tax implications of selling i.e. to
defer capital gains or to eliminate capital gains.
• Desire to maintain effective voting control of the

company.
• Desire to participate in the stock’s future returns.
• Lock-up period constraints or insider restrictions on
the selling of shares.
• Illiquidity of the stock.
Rationale for holding concentrated positions in privately
owned businesses: The business owner
• May find it premature to sell the company because
it has just entered its growth phase;
• May have a desire to maintain total control of the
company;
• May have a desire to give senior management and

Considerations Affecting All Concentrated
Positions (Covering Section 3.2.1-3.4.2)

Various constraints faced by owners of concentrated
positions that restrict their flexibility to either sell or hedge
their shares are as follows.
1) Tax Consequences of an Outright Sale: Simply selling
the concentrated positions with highly appreciated
current market values compared to their original cost
(cost basis) result in an immediate taxable capital
gain (selling price – tax cost basis) and associated tax
liability for the owner.
2) Liquidity: Concentrated position in a publicly traded
stock is illiquid when the size of the concentrated
position is large relative to the trading volume of the
company’s shares or when the owners have legal
constraints with regard to the timing and amount of

any sales. Concentrated position in privately traded
shares is illiquid because private company’s shares
have no readily available market. Similarly, direct
ownership of investment in real estate is also illiquid
due to large transaction size and lack of availability
and timeliness of information.
3) Institutional and Capital Market Constraints: They can
further be classified as follows:
a) Margin-Lending Rules: Margin-lending rules are the
rules that determine the maximum amount that a
bank or brokerage firm is allowed to lend against


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Concentrated Single-Asset Positions

the securities positions owned by their customers.
Certain types of secured lending that is reported as
“off-balance sheet” debt (i.e. prepaid variable
forward, discussed below) are considered as
“sales” for margin rule purposes (but not for tax
purposes; implying that capital gains taxes can be
deferred or eliminated) and are therefore NOT
subject to margin rules.
There are two types of Margin Regime.
i. Rule-based system: In a rule-based system, the
maximum amount that can be lent against the
security owned by the customer (investor)
depend on strict rules regarding the purpose of

the loan. For example, in U.S. if the loan
proceeds will be used to buy additional
securities, then the bank can lend a maximum
of 50% of the value of the stock.
ii. Risk-based system: Under a risk-based system if
the stock is completely hedged by a long put,
then bank or brokerage firm can lend 100% of
the put strike to the investor even if the loan
proceeds will be used to buy additional
securities. Portfolio margining is an example of a
risk-based margin regime. The risk-based rules
provide greater flexibility to advisors with regard
to obtaining desired economic and tax
outcomes.
b) Securities Laws and Regulations: Company insiders
and executives are subject to various regulatory
selling constraints i.e. prohibition from selling during
black-out periods, or when in possession of material
nonpublic information; disclosure/reporting
requirements; restrictions regarding the timing and
volume of sales or hedging transactions.
c) Contractual Restrictions and Employer Mandates&
Policies: Contractual restrictions include IPO “lockup” periods. Employer mandates and policies
include a prohibition from buying/selling during
“blackout period”; “right of first refusal” that require
equity-holders of a private company to first give
other equity investors the right to buy the interest at
the same price and under the same conditions as
being offered to a third party before selling their
investment to a third party. These restrictions and

mandates tend to reduce the liquidity of an
investment holding.
d) Capital Market Limitations: Factors that affect
dealers’ decision to execute collars or use other
hedging techniques include:
• Ability to borrow shares: The ability to borrow shares is
critically important for the dealer to manage its
counterparty risk. The investor executing the hedging
transaction with the dealer can lend its “long” shares
to the dealer (provided that the investor has no
restrictions on lending); however, for tax purposes,
the transaction is considered as a “sale”.
• Liquidity of the stock: The liquidity of the stock is also
very important for the dealer to periodically adjust its

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hedge.
• Average daily trading volume: The average daily
trading volume of the stock is important for the
dealer to analyze shares’ propensity to move in
upward or downward direction. This implies that
dealers prefer to enter into a hedging transaction for
the shares of a company with an established trading
history/pattern.
4) Psychological Considerations: Psychological
considerations of clients that negatively affect the
decision making of holders of concentrated positions
and act as constraints to dealing with concentrated
positions include:

a) Emotional Biases: For example,
• Overconfidence and familiarity (illusion of
knowledge)
• Status quo bias
• Nạve extrapolation of past returns
• Endowment effect
• Loyalty effects
b) Cognitive Biases: For example,
•
•
•
•
•

Conservatism
Confirmation
Illusion of control
Anchoring and adjustment
Availability heuristic

Emotionally biased clients should be advised differently
from the clients with cognitive errors i.e. emotionally
biased clients should be advised by explaining the
effects of investment program on various investment
goals and by determining a deceased person’s
objective in owning the concentrated position and
bequeathing it; whereas clients with cognitive errors
should be advised by providing quantitative measures
e.g. S.D. and Sharpe ratios.
NOTE:

Behavioral biases are discussed in detail in Reading 6
and 7.

Practice: Example 1,
Volume 2, Reading 11.

3.5

Goal-Based Planning in the ConcentratedPosition Decision-Making Process

Investment advisors can incorporate psychological
considerations of their clients holding concentrated
positions into asset allocation and portfolio construction
decisions using “Goal-based Planning”. Goal-based
planning involves dividing a portfolio into following three
notional “risk buckets” addressing different investment
goals and then determining appropriate asset allocation


Reading 11

Concentrated Single-Asset Positions

consistent with each risk bucket and its corresponding
goals.
1) Personal Risk Bucket: The goal of personal risk bucket
is to protect the client from poverty or significant
decrease in standard of living. Hence, asset
allocations to this bucket focus on investing in low-risk,
low-return investments for the purpose of minimizing or

eliminating loss. These low-risk investments include
client’s primary residence, certificates of deposits,
Treasury bills, and other “safe haven” investments.
2) Market Risk Bucket: The goal of market risk bucket is to
maintain the current standard of living. Hence, asset
allocations to this bucket focus on investing in assets
with average risk-adjusted market returns, e.g. stocks
and bonds.
3) Aspirational Risk Bucket: The goal of aspirational risk
bucket is to increase wealth substantially. Hence,
asset allocations to this bucket focus on investing in
high-risk, high-return assets e.g. client’s concentrated
positions (i.e. privately owned businesses, investment
real estate, concentrated stock positions, stock
options etc.).
• Owner’s Primary Capital: Owner’s primary capital is
the assets owned by the client other than the
concentrated position. It comprises assets that are
allocated to his or her personal and market risk
bucket.
• Primary capital requirement: The capital needed to
be allocated to client’s personal and market risk
buckets is referred to as primary capital requirement.
• Owner’s Surplus Capital: It is the capital in excess of
the primary capital requirement. It comprises assets
that are allocated to his or her aspirational risk
bucket.
Goal-based planning approach helps investors in
identifying concentration risk and in determining
whether a sale or monetization will enable the investor to

meet his/her financial goals.
• For example, if investor’s goal is to maintain its
current standard of living after retirement, then
he/she should allocate a significant amount of the
portfolio to the personal risk and market risk buckets
as well as should diversify his/her concentrated
position in a single asset.
• The sale or monetization of the concentrated
position should generate sufficient after-tax
proceeds to help investor achieve financial
independence, i.e. meet his/her lifetime spending
needs and desires.

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Various factors are considered to determine the ability
of the sale or monetization of the concentrated position
to achieve financial independence for the owner i.e.
i. The lifetime spending needs and desires of the client
after the sale or monetization of the concentrated
position;
ii. The primary capital requirement, i.e. present value of
the capital needed to meet client’s lifetime
spending needs with low or zero probability of
running out of money.
iii. Current value of the concentrated position. The
value of concentrated position will vary depending
on the type of monetization strategy used by the
investor.
iv. Current value of owner’s primary capital.

v. The current value of the concentrated position under
one or more of the monetization strategies to
determine whether it is sufficient to meet client’s
primary and surplus capital requirements.

Practice: Example 2,
Volume 2, Reading 11.

3.6

Asset Location and Wealth Transfers

Asset location and wealth transfers are the two tools
available to investors for addressing their concentrated
positions.
Asset location decision refers to locating/placing
investments (different asset classes) in appropriate
accounts. Asset location decisions primarily depend on
the tax regime governing the investor.
Implications of asset location for the owners of
concentrated positions:
• Assets that are taxed heavily/annually should be
held in tax deferred and tax exempt accounts.
• Assets that are taxed favorably (i.e. at lower rates)
and/or tax deferral should be held in taxable
accounts.
Wealth transfer planning refers to determining the most
tax-efficient method and timing of wealth transfer.
• Transfer tax minimization strategies that can be used
at the time before substantial appreciation of the

value of the concentrated position include:
A. Direct gifts to family members
B. Direct gifts to long-term trusts
C. Ownership transfer estate freeze (or an early of an
estate): This strategy seeks to transfer future
appreciation (typically of a corporation,
partnership, or limited liability company) to the
next generation at little or no gift or estate tax
cost. Under this strategy, only the current market
value (not the future appreciation) of the equity


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Concentrated Single-Asset Positions

position is subject to gift or wealth transfer tax.
In a typical corporate estate tax freeze involving a
recapitalization of a closely held family-owned
corporation,
• The older generation owning all of the stock of the
company exchanges their existing company’s stock
for two newly issued classes of stock i.e.
i. Voting preferred shares: The value of these shares
is equal to the current value of 100% of the
corporation. These shares are held by the older
generation. These shares pay a fixed rate like
bonds; thus, their value does not appreciate

greatly.
ii. Non-voting common shares: They have current
nominal value and are gifted to the next
generation. The value of common shares increase
with the future appreciation in the value of the
corporation. However, the appreciation is not
subject to any gift or estate tax until the common
shares are passed by gift or bequest to the next
generation.
• Due to the voting power attached to preferred
shares, the control of the company is retained by the
older generation.
• The preferred shares can be redeemed and voting
rights may be provided to common shareholders
upon retirement or death of the older generation.

transfer as well as estate tax savings if the value of
concentrated position appreciates by the time the
parent dies.
Example:
Suppose the value of concentrated position is $10 million
and the combined discount is 30%. The parents decide
to transfer 25% interest to their children. Hence,
Value of interest gifted to children = 25% × $10 million ×
(1 – 30%)
= $1.75 million
If the value of $10 million concentrated position
increases to $35 million by the time the parent dies,
Value of interest held by children = 25% × $35 million
= $8.75 million

Gift tax valuation = $1.75 million

Practice: Example 3,
Volume 2, Reading 11.

3.7

Concentrated Wealth Decision Making: A FiveStep Process

NOTE:

Step 1

The corporate estate tax freeze is not allowed in all
jurisdictions.

•Identify, establish , &
document objectives &
constraints of the
owner of the
concentrated position
as well as the impact of
those constraints.

It must be stressed that it is highly important for an
advisor to plan the management of an owner’s
concentrated positions as early as possible because
over time, as the concentrated position appreciates in
value, wealth transfer tools (although still useful) tend to
be less efficient, more complex, and expensive to

implement.
• After the significant appreciation of the value of the
concentrated position, the transfer tax can be
minimized by contributing the concentrated position
to a limited partnership and gifting the limited
partnership interests to the next generation.
• The value of a limited partnership interest is typically
less than the proportionate value of the underlying
assets (discount of 10-40%) due to the following two
reasons:
1) Lack of marketability: Typically, family limited
partnership interests are restricted and difficult to
sell outside the family.
2) Lack of control: Since the control of the
partnership (as represented by general
partnership interest) and the concentrated
position within it is retained by the parents, the
value of limited partner’s non-controlling interest is
low.
• Contributing the concentrated position to a limited
partnership generate gift tax savings at the time of

Step 2
•Identify tools or
strategies that can be
used to meet owner's
objectives consistent
with constraints.

Step 4

Step 3
•Thoroughly compare
tax advantages and
disadvantages of each
tool or strategy.

Step 5
•Formulate and
document an overall
strategy that best
meets client's
objectives after
comparing tax & nontax advantages and
disadvanatges of each
alternative tool.

•Thoroughly compare
non-tax advantages
and disadvantages of
each alternative tool or
strategy


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Concentrated Single-Asset Positions
4.

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MANAGING THE RISK OF CONCENTRATED SINGLE-STOCK
POSITIONS

Common Tools/strategies that can be used to mitigate
the risks of any concentrated position are as follows.
These tools may vary depending on the jurisdiction.
A. Outright sale: It refers to simply selling the security to
reduce concentrated position.
Advantages:
• It is the simplest method.
• It provides investors the maximum flexibility with
regard to disposition or reinvestment of sale
proceeds.
• It facilitates the owner to reduce overall portfolio risk
and achieve diversification.
Disadvantages:
• It incurs tax liability (i.e. capital gains tax).
• It is most suitable for publicly traded shares and for
positions with no sale restrictions.
• An outright sale eliminates any upside price
potential associated with the concentrated position
and also results in loss of dividends and voting
power.
B. Monetization strategies: Monetization strategies
facilitate owners to mitigate the risks of a
concentrated position without incurring tax liabilities.
Examples of monetization strategy that involve
borrowing include:
• Margin loan: It is a loan against the value of a

concentrated position.
• Recourse and non-recourse debt
• Fixed and floating rate debt
• Loans embedded within a derivative (e.g. a prepaid
variable forward)
Other monetization strategies include:
• Short sales against the box
• Restricted stock sales
• Public capital market-based transactions i.e. debt
exchangeable for common offerings
• Rule 10b 5-1 plans and blind trusts (U.S.)
• Exchange funds (U.S.)

C. Hedging: This strategy involves hedging the value of
the concentrated asset using derivatives i.e.
exchange-traded instrument (i.e. options or futures) or
an over-the-counter (OTC) derivative (i.e. OTC
options, forward sale or swap). However, such
hedging transactions must not be deemed as
constructive sale to avoid incurring taxes. Transactions
that may be deemed as constructive sale of an
appreciated stock include:
• A short sale of the same or substantially identical
property;
• An offsetting notional principal contract on the
same or substantially identical property;
• A futures or forward contract to deliver the same or
substantially identical property;
4.1

Introduction to Key Tax Considerations

The risk of a concentrated asset (e.g. stock) can be
mitigated by shorting the stock directly or by using
derivatives. Either method generates the same
economic outcome; but they are taxed differently. Most
of the tax regimes that govern taxation of financial
instruments are comprehensive in nature. However, they
are not always internally consistent, i.e. tax treatment of
different tools varies depending on tax regimes. The
internal inconsistency of tax codes allow investors to
reduce their tax risk or generate significant tax savings
by selecting the tool that provides the most efficient
economic and tax result.
4.2

Introduction to Key Non-Tax Considerations
(Covering Section 4.2.1-4.2.6)

Non-tax considerations that must be considered with
regard to selecting the optimal derivative instrument for
hedging the concentration risk include:
1) Counterparty Credit Risk: In an OTC derivative the
investor is exposed to counterparty credit risk. In
contrast, exchange-traded derivatives are not subject
to credit risk of counterparty or have lower
counterparty credit risk.
2) Ability to Close Out Transaction Prior to Stated
Expiration: Since exchange-traded derivatives are
highly liquid, investors can easily close-out the

transaction by entering into offsetting transactions
before contract’s stated expiration. Whereas in OTC
derivatives, early termination of a particular contract
usually involves a concession in return.
3) Price Discovery: Exchange-traded derivatives
facilitate price discovery due to their standardized
terms and conditions. By contrast, in OTC derivatives,
price is determined through negotiation by the parties
involved in a transaction.
4) Transparency of Fees: Fees (commissions) and
expenses in exchange-traded transactions are


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Concentrated Single-Asset Positions

relatively more transparent than that of OTC
transactions.
5) Flexibility of Terms: Due to customized nature of OTC
derivatives, they are relatively more flexible to meet
the specific needs of counterparties compared to
standardized exchange-traded instruments.
6) Minimum Size Constraints: Exchange-traded
derivatives typically have a smaller minimum size
constraint than OTC derivatives.
4.3

Strategies

Three primary strategies that can be used to mitigate risk
of a concentrated position in a common stock are as
follows.
1) Equity monetization
2) Hedging
3) Yield enhancement
4.3.1) Equity monetization
Equity monetization involves borrowing against the value
of the concentrated stock position and reinvesting the
loan proceeds to achieve diversification. It allows an
investor to cash out the appreciated value of a
concentrated stock position without incurring any tax
liability at the time of cashing out. When the stock
position is hedged, an investor can achieve a high loanto-value (LTV) ratio.
Advantages of Equity monetization:
• It allows an investor to transfer the economic risk and
reward of a stock position without actually
transferring the legal and beneficial ownership of
that asset; implying that they do not constitute a sale
or disposition of the appreciated concentrated
position. As a result, the capital gain tax on the
appreciated long position can be deferred.
• It helps the owner to mitigate concentration risk by
generating the same amount of cash as that by an
outright sale but without incurring an immediate tax
liability.
• This strategy is useful for stock positions with sale
restrictions or contractual restrictions.
• This strategy is preferred to use when the owner (with
a large % of share holdings) wants to retain control

of the company or do not want another investor to
acquire a large block of company shares.
Types of tools/strategies of Equity Monetization (Covering
Section 4.3.1.1)
A. A short sale against the box: A short sale against the
box is a transaction in which an investor actually owns
the stock and protects its long position by short selling
the same stock (i.e. settles the sale with borrowed
shares). The short sale proceeds can be invested in a
diversified portfolio of securities.
• Due to long and short position in the same number

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of shares of the same stock, any future change in
the stock’s price will have no effect on the investor’s
economic position. Also, any dividends or other
distributions received on the long shares are
transferred to the lender of shares.
Advantages:
• The short sale against the box enables an investor to
lock in a profit without recognizing the related
capital gains tax.
• The short sale against the box creates a riskless
position due to simultaneous long and short position
in the same stock. As a result, the investor can earn a
money market rate of return on the stock position
and can borrow with a high loan to value (LTV) ratio
against the position (e.g. up to 99% of the value of
the hedged stock) with no restrictions on the use of

the loan proceeds.
• A short sale against the box helps investors to
potentially defer the capital gains tax on a
concentrated position.
• It is the least expensive technique as:
o It has low net cost of borrowing because the
interest earned on the hedged stock position can
be used to pay the interest expense of the margin
loan.
o It has low dealer fees compared to synthetic short
sales transactions.
B. A total return equity swap: It is a bilateral contract in
which an investor agrees to pay out the total return of
the equity, including its dividends and capital
appreciation or depreciation, to the dealer; and in
return, receives a regular fixed or floating cash flow
(i.e. any loss in the value of the equity + One-month
LIBOR - Dealer spread).
• Due to derivative dealer spread paid by the investor,
the money market rate of return earned by the
investor will be slightly less than that of a short sale
against the box.
• Because the stock position is completely hedged, an
investor can borrow with a high LTV ratio against the
position.
C. Options (forward conversion with options): It involves
constructing a synthetic short forward position against
the long position in the asset.
Synthetic short Forward = Long Put + Short Call
Where, the long put and short call options are on the

same underlying asset with the same strike price and the
same termination date.
• When the stock price falls to zero
investor
exercises the long put option
delivers the stock to
the dealer and receives the put strike price.
• When the stock price increases
the counterparty
exercises the call option
investor delivers the stock
to the counterparty and receives the call strike price.


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Concentrated Single-Asset Positions

Advantage:
• Synthetic short forward position is riskless; as a result,
the investor can earn a money market rate of return
on the position and can borrow with a high loan to
value (LTV) ratio against the position.
• Capital gains tax on the appreciated long position
can be deferred if the long and short (or synthetic
short) position is treated separately for tax purposes.
D. An equity forward sale contract or single-stock futures
contract: It is a bilateral contract where the investor
agrees today to exchange the stock at some future
date at a fixed price; and in return, receives the

“forward price” from the dealer at some future date.
Advantage:
• An equity forward sale position is riskless; as a result,
the investor can earn a money market rate of return
on the position (represented by forward price) and
can borrow with a high loan to value (LTV) ratio
against the position.
Disadvantage:
• If at contract termination, market price of the stock
> forward price, investor receives the forward price
and loses any upside price potential.
4.3.1.2 Tax Treatment of Equity Monetization Strategies
The investor should select the most tax-efficient equity
monetization strategy.
Characteristics of a Tax-efficient hedging tool:
• Unwinding or cash settlement of the hedging
transaction results in a long-term gain rather than
short-term gain.
• Unwinding or cash settlement of the hedging
transaction results in a short-term and currently
deductible loss.
• The physical settlement of the contract generates a
long-term gain rather than a short-term gain.
• Monetization strategy has carrying costs that are
currently deductible.
• Hedging transaction has no impact on the taxation
of dividends or distributions received on the shares.
General Income Tax Regimes
A. Common Progressive Regime: Under this regime,
ordinary income is taxed at progressive tax rates

whereas all three investment income (i.e. dividends,
interest, & capital gains) are taxed at favorable tax
rates. It is the most common tax regime.
B. Heavy Dividend Tax Regime: Under this regime,
• Ordinary income is taxed at progressive tax rates.
• Interest and capital gains are taxed at favorable tax

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rates.
• Dividends are taxed at ordinary rates.
C. Heavy Capital Gain Tax Regime: Under this regime,
• Ordinary income is taxed at progressive tax rates.
• Interest and dividends are taxed at favorable tax
rates.
• Capital gains are taxed at ordinary rates.
It is the least common tax regime.
D. Heavy Interest Tax Regime: Under this regime,
• Ordinary income is taxed at progressive tax rates.
• Dividends and capital gains are taxed at favorable
tax rates.
• Interest income is taxed at ordinary rates.
E. Light Capital Gain Tax Regime: Under this regime,
• Ordinary income, interest, and dividends are taxed
at progressive tax rates.
• Capital gains are taxed at favorable tax rates.
It is the second most commonly observed tax regime.
F. Flat and Light Regime: Under this regime,
• Ordinary income is taxed at flat tax rates.
• Interest, dividends, and capital gains are taxed at

favorable tax rates.
G. Flat and Heavy Regime: Under this regime,
• Ordinary income, dividends and capital gains are
taxed at flat tax rates.
• Interest income is taxed at favorable tax rates.
4.3.2) Lock in Unrealized Gains: Hedging
Hedging provides protection against downside risk of the
concentrated position but without losing the upside
price potential associated with the stock.
Two major hedging approaches (Covering Section
4.3.2.1 – 4.3.2.2):
1) Purchase of puts: This strategy is referred to as
“protective put”.
Protective Put = Long stock position + Long Put position
• Purchasing put option requires the payment of cash
up front in the form of option premium. The put
option premium depends on various factors i.e.
o Volatility of the stock: The more (less) volatile the
stock, the higher (lower) the put option premium
will be.
o Strike price of the option: The higher (lower) the
strike price of a put option, the higher (lower) put


Reading 11

Concentrated Single-Asset Positions

option premium but the smaller (greater) the
downside risk will be.

o Maturity: The shorter (longer) the maturity, the
lower (higher) the put option premium will be.
Advantages:
• A long put option on the concentrated stock
position provides downside protection (by setting a
floor price) while retaining the upside potential but
without recognizing the related capital gains tax.
• A long put option on the concentrated stock
position enables an investor to retain any dividends
received and voting rights.
Strategies that can be used to reduce the cost of
acquiring puts (i.e. option premium) are as follows:
• Buying at-the-money or slightly out-of-the-money
put options with relatively lower option premium.
• Using “put-spread” strategy that involves buying a
put option with a higher exercise price and selling an
otherwise identical put option with a lower strike
price but with the same maturity as the long puts.
o Selling put generates some premium income,
which can be used to partially finance the cost of
long put.
o However, by selling put option, investor faces
downside risk whenever the underlying stock price
further declines below the strike price of the short
put.
• Using a “Knock-out” put option in which once the
stock price increases to a certain level, the
downside protection disappears before its stated
expiration date. As a result, it has lower option
premium than that of “plain vanilla” put. It is an

“exotic” option and is traded only over-the-counter
for fairly large positions.
• Using a cashless or zero-premium collar (discussed
below).
2) Cashless (or zero-premium) Collar: In a cashless
collar, an investor purchases an out-of-the-money put
option (i.e. with a strike price ≤ current stock price) on
the underlying position and simultaneously sells a call
option with the same maturity but with the same strike
price > current stock price.
Cashless collar = Long Put + Short Call
• An investor receives premium income by selling a
call option, which can be used to fully finance the
purchase of the put option.
• However, the short call option puts a cap on the
opportunity for unlimited capital appreciation by
setting a ceiling price established by the covered
call*. It must be stressed that using a cashless equity
collar reduces, not eliminates, the investment risk.
• When stock price > call strike price, call option is
exercised and the investor delivers his long shares
and receives
Call strike price + Call premium received – Put

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premium paid
• When at expiration, stock price lies between strike
price of put and call option, both options expire
worthless and the investor receives (Call option

premium received – Put option premium paid).
• When stock price < put strike price, the investor
exercises put option and delivers his long shares and
receives
Put strike price + Call premium received – Put
premium paid
*The upside potential can be increased using different
approaches i.e.
i. By buying put option with a lower put strike price and
selling call option with a higher strike price because
the lower the put strike price, the lower the put
option premium whereas the higher the call strike
price, the lower the call option premium.
ii. Using a “put-spread” strategy in conjunction with
selling a call option of the same maturity: Selling a
put generates some premium income that can be
used to partially finance long put option. However,
investor faces downside risk whenever the underlying
stock price further declines below the strike price of
the short put but will have more upside potential
than with a plain vanilla cashless collar.
iii. Using a Debit collar: It involves paying a portion of
put premium “out of pocket”. Using debit collar
allows investor to sell a call with a higher strike price
in order to finance the net cost of the put.
Important to Note: In Exchange-traded options, the
premium received on short call option is taxed as a
short-term capital gain in the year of expiration of
option.
4.3.2.3 Prepaid Variable Forwards

A pre-paid variable forward (PVF) is a forward contract
in which the investor agrees to sell a specific number of
shares in the future at pre-specified future date in return
for an upfront cash payment from the counterparty.
The number of shares to be actually delivered at
maturity will be determined by some preset formula e.g.
based on long put strike price and a short call strike
price. That is,
• If the share price at pre-specified future date is < put
strike price:
o When PVF is physically settled: An investor has to
deliver all of its shares.
o When PVF is cash settled: An investor has to pay
the dealer the then-current value of shares in cash.
• If the share price at pre-specified future date is
greater than put strike price but less than call strike
price:
o When PVF is physically settled: An investor has to
deliver shares worth put strike price.
o When PVF is cash settled: An investor has to pay
the dealer put strike price in cash.
• If the share price at pre-specified future date is >


Reading 11

Concentrated Single-Asset Positions

call strike price:
o When PVF is physically settled: An investor has to

deliver shares worth (put strike price + value of
shares in excess of the call strike price).
o When PVF is cash settled: An investor has to pay
the dealer [put strike price + (then-current price of
shares – call strike price)]
An investor can enter into another PVF to generate the
liquidity to meet its obligations under the original PVF.

Practice: Example 4,
Volume 2, Reading 11.

4.3.2.3 Choosing the Best Hedging Strategy
The optimal hedging strategy is the one that is most taxefficient. Unlike common shares, restricted company
shares and employee stock options are taxed similar to
other forms of compensation income (salary & bonus)
i.e. at significantly higher rates than long-term capital
gains income.
Mismatch in Character: When the investor has ordinary
income on the concentrated position but capital loss on
the hedge, it is referred to as a mismatch in character.
Due to this mismatch in character, the capital loss on the
hedge may not be currently deductible because capital
losses are generally deductible against capital gains, not
against ordinary income. In the U.S., mismatch in
character can be avoided by using a swap with an
optionality of a collar embedded within it.

Practice: Example 5,
Volume 2, Reading 11.

4.3.3) Yield Enhancement
In order to enhance the yield of a concentrated stock
position while decreasing its volatility, investors can write
covered calls against some or all of the shares.
Covered Call = Long stock position + Short call position
(with a strike price > current stock price)
• Writing a covered call generates cash up front in the
form of option premium but provides limited upside
potential (i.e. call strike price + premium received).
• The downside protection on share price is limited to
the option premium received on the front-end of the
transaction. However, covered call strategy may
help in psychologically preparing the owner to
dispose off those shares.
• This strategy is preferred to use when the stock is
owned by the investor and when the stock price is
expected to move in a trading range for the
foreseeable future.
• Covered call strategy involving short calls with

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staggered maturities and strike prices can be used
as an alternative to a structured selling program.
4.3.4) Other Tools: Tax-Optimized Equity Strategies
With regard to managing risk of a concentrated stock
position,
1) Tax-optimized equity strategies can be used as an
index-tracking strategy with active tax management:
An index-tracking separately managed portfolio is

quantitatively designed to closely (not perfectly) track
a broad-based market index on a pre-tax basis, and
outperform it on an after-tax basis.
• An index-tracking separately managed portfolio is
funded by cash, from the partial sale of the
investor’s concentrated stock position, from the
monetization proceeds derived from the hedged
stock position, or a combination of any of these.
• These strategies use opportunistic capital loss
harvesting and gain deferral techniques that can be
used by the investor to sell a commensurate amount
of concentrated stock without incurring any capital
gains taxes.
2) Tax-optimized equity strategies can be used in the
construction of completeness portfolios: Constructing
a completeness portfolio is a strategy in which an
investor “completes” investment in a single security
(i.e. concentrated stock position) by purchasing a
basket of other liquid securities (having low
correlation with the concentrated stock) to hold a
portfolio that tracks the broadly diversified market
benchmark. By combining a concentrated stock
position with additional liquid securities, the
concentration risk is reduced and the portfolio may
behave like some desired index.
• Completeness portfolio uses capital loss harvesting
that facilitates the investor to sell a commensurate
amount of concentrated stock without incurring any
capital gains tax.
• With the passage of time, the size of the

concentrated stock position declines to zero and the
investor ends up holding a diversified portfolio of
lower-basis (not current) stocks.
Limitations:
• Completeness portfolio strategy is only suitable for
investors who have access to other liquid assets
besides their concentrated stock position because
constructing a completion portfolio requires
significant liquidity.
• Implementing a completeness portfolio strategy
tends to require significant time.
• Liquidation of a diversified market portfolio incurs a
capital gain tax.


Reading 11

4.3.5) Other Tools: Cross Hedging
Cross hedge (or indirect hedge) involves hedging a
concentrated position by using derivatives on a
substitute asset (a security or basket of securities or a
broad or target investable index)that has an expected
high correlation with the investor’s concentrated stock
position. Cross hedge is preferred to use when:
• Derivatives on the concentrated stock are not
available;
• Direct hedging involves higher execution costs; or
• Investor is restricted from executing a hedging
transaction.
Advantage of cross hedge: Cross hedge helps investors

to hedge market and industry risk.
Disadvantage of cross hedge: Using cross hedge, an
investor cannot hedge company-specific risk of the
concentrated position.

5.

•
•
•
•
•

Valuation level of target companies
Tax rate applicable to a particular exit strategy
Condition of the credit markets
Level of interest rates
Degree of buying power in the marketplace
(strategic and financial buyers)
• Currency valuation
Profile of a Typical Business Owned by a Private
Client

Typically, the business represents the major portion of the
owner’s net worth and is owner’s primary source of
income. It is also a source to meet legacy and
charitable objectives.
NOTE:
Business that is privately owned and whose value ranges
between $10 million to over $500 million is referred to as

“Middle-market” business.
5.2

Important to Note: To avoid risk of decline in the value of
concentrated stock position associated with companyspecific factors while simultaneous increase in the value
of proxy asset or index above the call strike or short-sale
price, investors should use long put options rather than
cashless collar or short position.
4.3.6) Exchange Funds
In exchange funds, a number of investors, each with a
different concentrated position, pool together their
assets and thereby diversify their holdings without
incurring immediate capital gains tax because partners’
cost basis in the partnership units is equal to the cost
basis of the contributed concentrated stock positions.
• Each partner then owns a pro rata interest in the
partnership.
• For tax purposes, each partner has a minimum seven
year lock up period during which the investor cannot
withdraw or sell its investments. After the lock-up
period, the investor can withdraw a pro rate share of
the fund.

MANAGING THE RISK OF PRIVATE BUSINESS EQUITY

From the perspective of the seller of concentrated
position, attractiveness of the market depends on
various factors, including

5.1

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Concentrated Single-Asset Positions

Profile of a Typical Business Owner

• Due to demands of managing and operating the
business, the business and personal lives of business
owners are usually intertwined, involving both family
members and business partners.
• Additionally, long-term objectives of business owners
are non-static in nature.

• Typically, business owners tend to underestimate
their business’ risk and overestimate the value of their
business.
• Besides aging of the owner, business may be
exposed to various risks i.e. competition, illness of the
owner or a family member etc. Also, a business
owner may have no exit plan and have little
knowledge regarding various hedging and
monetization strategies.
5.3

Monetization Strategies for Business Owners
(Covering section 5.3.1 – 5.3.9)

The attractiveness of the monetization strategies for
business owners depend on the conditions in the capital

market and the merger and acquisition deal market.
Types of Monetization Strategies available to Business
Owners:
1) Sale to Strategic Buyers: Strategic buyers are
competitors or other companies engaged in the
same or similar line of business as the seller. Strategic
buyers tend to invest in the business with a long-term
investment objective. They usually pay the highest
price for the business to realize potential synergistic
benefits (related to revenue, costs etc.) and consider
the acquisition of the business as a low-risk and
attractive means to enhance revenue and earnings
growth, especially in a slow growth environment.


Reading 11

Concentrated Single-Asset Positions

Advantages of sale to a strategic buyer:
• This strategy allows the owner to reduce
concentration risk and to generate liquidity to
diversify.
• This strategy generates the highest current proceeds
for the owner and allows the seller to avoid higher
tax rate in future.
• Selling the business to a strategic buyer relieves the
seller from running the business and maintaining its
day-to-day operations.
2) Sale to Financial Buyers or Financial sponsors:

Financial buyers are the investors who make direct
investment in mature and stable middle-market
businesses. Private equity firm is an example of a
financial buyer. Financial buyers tend to a pay a
lower price compared to strategic buyers as they,
unlike strategic buyers, lack the opportunity to obtain
financial and operational synergistic benefits.
Financial buyers tend to have a short-term investment
objective as they are interested in generating high
internal rate of return on their invested capital over a
short time period (3-5 years)and the future exit
opportunities from the business.
3) Recapitalization or a leveraged recapitalization: In a
recapitalization strategy, a business owner sells a
large portion (60-80%) of its business equity to a seller
(i.e. private equity firm) for cash and retains a minority
ownership interest (20-40%) in that recapitalized entity.
The investor can invest those after-tax cash proceeds*
in other asset classes to create a diversified portfolio.
The retained minority ownership interest in the business
motivates the owner to grow the business.
• Recapitalization strategy is a type of “staged” exit
strategy as it allows the owner to generate liquidity in
two stages i.e. one up front and another typically
within 3-5 years when the private equity seeks to exit
the investment.
• Recapitalization strategy is preferred to use when a
business owner wants to reduce concentration risk
and generate liquidity without selling the business
entirely.

*After-tax amount monetized by the recapitalization =
Sales price × % of equity sold × (1 – Tax rate)

For tax purposes, the cash received by the owner is
taxed and the owner may usually receive a tax deferral
on the stock rolled over into the newly capitalized
company.
In a leveraged recapitalization, besides investing equity,
a private equity firm also arranges debt for the business
with senior and mezzanine (subordinated) lenders. As a
result, the owner is no longer required to personally
guarantee bank debt and can focus on growing the
business and maintaining day-to-day operations.

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Advantages of Recapitalization:
• Recapitalization strategy allows the owner to reduce
concentration risk, to generate liquidity to diversify,
to minimize tax liability before expected increase in
tax rates, and to sell the business within short time
period (3-5 years).
• Using recapitalization allows the seller to retain his
identity as the CEO of his firm.
• Capital (equity) obtained through recapitalization
can be used to expand the business and enhance
earnings and value of the company within a short
time period.
Disadvantages of Recapitalization:
• Since private equity firms are financial buyers, they

typically pay a lower price relative to strategic
buyers.
• By selling a large ownership interest to private equity
firm, the business owner loses control of the
company.
4) Sale to Management or Key Employees: A
management buyout (MBO) is a strategy, which
involves transferring control of the business to a group
of senior managers or employees. Since these key
employees may lack skills to successfully run a
business, they are not able to raise sufficient funds to
buy the company. Hence, the business owner may
have to finance a portion of a sale price by
accepting a significant portion of the purchase price
in the form of a promissory note, under which a
significant amount of the purchase price is deferred
and sometimes conditional on meeting or exceeding
certain financial performance targets.
• It must be stressed that the business should be sold to
key employees only if the pricing, terms, and
conditions of their purchase offer matches or
exceeds that of a third-party buyer.
• A failed attempt to do MBO may have potential
negative effects on the employer-employee
relationship.
5) Divestiture (Sale or Disposition of Non-Core Assets):
Divestiture is a strategy that allows the business owner
to generate some liquidity to diversify (without losing
control of the business) by selling non-core assets i.e.
assets that are not essential for the continued

operation or for the future growth of the business.
6) Sale or Gift to Family Member or Next Generation:
Business owners can sell or transfer their business to
next generation through tax-advantaged gifting
strategies.
• When the business is sold to family members but
family members do not have the necessary capital
to buy the business, the owner may have to accept
a significant portion of the purchase price in the
form of a promissory note.


Reading 11

Concentrated Single-Asset Positions

• Transferring the business to the next generation
through gifting strategies is appropriate to use only if
the owner has sufficient capital available outside the
business to maintain his/her desired lifestyle.
7) Personal Line of Credit Secured by Company Shares:
A business owner can generate liquidity to diversify its
concentrated position without losing control of the
business and without incurring an immediate tax
liability (if structured properly) by obtaining a personal
loan against its private company shares.
• The loan gives the lender a “put” option that gives
the lender the right to demand repayment of the
loan. The business owner can meet the put
obligation either through its existing credit

arrangement or with a standby letter of credit issued
for this specific purpose. When the put option is
exercised, it triggers a taxable event for to the
business owner.
• In addition, in most jurisdictions, the interest expense
on the loan is currently deductible for tax purposes.
8) Going Public through an Initial Public Offering: A
business owner can dispose off its concentrated
position by making the company public through an
initial public offering (IPO). It is preferred to use if the
owner wishes to remain actively involved in the
company and does not want to exit from the
company in the near future.
• A private business can use an IPO strategy only if it
exhibits steady and significant growth in the past
and is considered attractive by the investors.
• IPO is an expensive strategy but may generate the
highest cash proceeds for the owner.
• By going public, private business owners lose their
privacy and authority. Also, the management may
face pressure to meet short-term quarterly revenue
and earnings expectations of the investment
community.

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• In a leveraged ESOP, the ESOP can borrow capital
from a bank to finance the purchase of the owner’s
shares, provided that the company has borrowing
capacity.

• An ESOP is a type of “staged” or “phased” exit
strategy like recapitalization.
Advantages of ESOP:
• ESOP allows the owner to partially diversify its
concentrated position without incurring an
immediate capital gains tax liability and without
losing control of the company and any upside
potential in the retained shares.
• For tax purposes, the business owner (only
shareholders of “Subchapter C” corporation) can
defer capital gain tax associated with the sale of
stock to an ESOP.
• ESOP strategy also eliminates capital gains tax by a
possible step-up in basis on death.
Disadvantage of ESOP: ESOP involves significant setup
and maintenance costs.
5.4

Considerations in Evaluating Different Strategies

The capital that the business owner receives after
monetizing the business primarily depends on the
strategy used by the owner (e.g. selling to a strategic
buyer generates the highest capital, in an earn-out or
MBO, the payout is contingent on the financial
performance of the company etc.). As stated
previously, the optimal hedging or monetization strategy
for the business owner is the one that maximizes the
after-tax proceeds, rather than sales price, which the
owner can reinvest in other liquid assets.

Practice: Example 6 & 7,
Volume 2, Reading 11.

9) Employee Stock Ownership Plan: A business owner
can sell some or all of the company’s shares by selling
shares to the employees through an employee stock
ownership plan (ESOP).
6.

MANAGING THE RISK OF INVESTMENT REAL ESTATE

Commonly, a substantial portion of the business’s value
and assets is comprised of real estate. A real estate may
also represent a significant portion of a private client’s
net worth. In addition, a real estate can be held as a
standalone investment. Like private business owners, real
estate owners tend to underestimate risks of their real
estate and overestimate their value.
Risks of Investment Real estate include:
• Concentration risk
• Illiquidity

• Greater tax liability on liquidation of the property as
the property may be highly appreciated relative to
its original tax cost basis.
6.1

Monetization Strategies for Real Estate Owners

The monetization strategies used by private businesses

and real estate owners should not solely be evaluated
for tax purposes; rather, investment advisors should also
consider business or investment rationale for the
transaction. That is, if the business or investment rationale


Reading 11

Concentrated Single-Asset Positions

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for the monetization or hedging transaction is justified,
then the advisors should select the most tax-efficient
strategy for executing that transaction.

are available that may help charitably inclined
investors to achieve their philanthropic goals. For
example,

From the seller’s perspective, attractiveness of the real
estate market depends on various factors, including

a) Donor-advised fund (DAF): An investor can transfer
the asset with potentially greater growth prospects
to a DAF in order to grow the asset tax free. When
the DAF then sells the property to generate
liquidity, it does not incur an immediate tax liability
because DAF is a charitable organization. The
accumulated depreciation deductions taken by

the investor cannot be “recaptured”, however. In
addition, the charitable contributions made to DAF
are tax deductible.

• Current valuation of real estate relative to historical
levels and future expectations;
• Tax rate applicable to a particular property and
lending conditions;
• Level of interest rates.
Types of Monetization strategies for Real Estate Owners
(Covering Section 6.1.1 – 6.1.4):
1) Outright sale of the property: It is the most common
strategy used by investors to reduce a concentrated
position in a particular property and to generate
liquidity to diversify asset portfolios.
2) Mortgage Financing: It refers to obtaining a fixed-rate
or floating-rate mortgage against the property. It the
second most common strategy used by investors to
reduce a concentrated position in a particular
property and to generate liquidity to diversify asset
portfolios BUT without incurring an immediate tax
liability. The investor can invest the loan proceeds in a
liquid, diversified portfolio of securities.
• The mortgage can be recourse or non-recourse
loan. In a non-recourse loan, the only resource
available to the lender in the event of default is the
mortgaged property.
Advantages of Mortgage financing:
• For tax purposes, the loan proceeds do not
represent “income” and therefore are not taxed. In

addition, if the value of real estate increases over
time, the investor can borrow additional debt
against the property without incurring a tax liability.
• If an investor achieves a cash flow-neutral LTV ratio*,
he/she is able to obtain a loan against the property
with no limitations on the use of the loan proceeds.
• *Cash-flow Neutral LTV (loan-to-value) ratio is the
ratio where the Net rental income generated from
the property = Fixed mortgage payment (composed
of interest expense and amortization of the loan
principal).
• Another benefit to the investor is that he/she can use
net rental income on the property to pay servicing
cost of the debt and other expenses of the property,
leading to zero net income from the real estate.
Disadvantage of Mortgage financing: Borrowing against
the property does not eliminate economic risk of the
underlying property.
3) Real Estate Monetization for the Charitably Inclined:
Charitably inclined investors are investors with
philanthropic goals e.g. to build an endowment fund
etc. Different strategies (that involve asset location)

b) Tax-exempt charitable trust: The investor can
transfer the appreciated property to the taxexempt charitable trust, which is a trust with
defined and charitable purpose. The charitable
contributions to the trust are tax deductible and
the trust would not be taxed on property sale
proceeds or investment income on the property.
4) Sale and Leaseback: It is a transaction in which the

owner of the property sells the property to another
party (e.g. REIT, institutional or private investor) and
then immediately leases it back from the buyer at a
rental rate and lease term that is feasible for the
buyer and on financial terms that are consistent with
the marketplace.
Advantages:
• A sale and leaseback strategy helps the investors to
generate liquidity to diversify their concentrated
position in real estate, to invest in the expansion of
the core business, or to use it for other strategic
purposes.
• Unlike traditional mortgage financing where the
investor can rarely achieve > 75% LTV ratio (unless
tenant is investment grade from a credit
perspective), the investor in a sale and leaseback
can obtain 100% LTV ratio.
• A sale and leaseback strategy helps an investor
remove any debt associated with the real estate
from the balance sheet.
• Unlike traditional mortgage financing where only the
interest expense component is deductible against
the company’s taxable income, rental payments
under a sale and leaseback structure are 100% tax
deductible against the company’s taxable income.
• Sale and leasebacks have flexible lease terms
(usually 10-20 years) with built-in renewal options.
• Sale and leasebacks facility is available even during
periods of tight credit markets.
Disadvantage: The investor would have to pay the

capital gains tax; as a result, the after-tax proceeds will
be less than 100% (unless there are capital loss carryforwards).


Reading 11

Concentrated Single-Asset Positions

Practice: Example 8,
Volume 2, Reading 11.

6.1.4) Other Real Estate Monetization Techniques
Other real estate monetization techniques include:
• Joint ventures
• Condominium structures
• Sale of buildings with the seller retaining control
through a long-term ground lease
• Mortgage tax-free exchange: It allows the owner of
appreciated property to hedge, monetize, defer,
and eventually eliminate the capital gains tax. It is
allowed in the U.S. only.

Practice: End of Chapter Practice
Problems for Reading 11.

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