Offsetting Capital Gains From a Business or Stock Sale

Instead of handing a third of your gain to the IRS the year you sell, you can invest the full amount, use losses from your new portfolio to offset the gain, and eventually eliminate the tax altogether

Case Study Summary

A Business Owner Sold Their Company for a $1 Million Gain, Invested the Full $1 Million Instead of Paying $350,000 in Taxes, and Left Their Family $2.35 Million More

By using tax-aware investing, they offset the gain with losses from their new portfolio and deferred the tax until death, when step-up in basis eliminated it entirely

Background: What Happens When You've Already Sold?

Sometimes selling isn't optional.

You sell your business. You sell a concentrated stock position. You sell a piece of real estate.

Now you have a large taxable gain, and a large tax bill due.

Is there a way to not pay it?

And the answer is tax-aware investing.

Let's look at a quick example.

Let's say you just sold a business with a $1 million taxable gain. Between federal and state taxes you owe about 35%, or $350,000.

The traditional path is to pay the $350,000 and invest the $650,000 that's left.

The tax-aware path is to invest the full $1 million in a diversified portfolio designed to generate losses that offset the gain. That defers the tax, and with the right planning eliminates it entirely.

 Table 1: Paying Tax Today vs. Investing the Full Amount

Paying taxes up front leaves $350,000 less invested, which costs your family $2.35 million over 20 years.

How Can Deferring Taxes Become Eliminating Taxes?

Deferring a tax bill is valuable because the money you would have paid keeps compounding.

But deferral alone still leaves a tax bill waiting for you down the road.

The key is step-up in basis.

When you pass an appreciated asset to your heirs at death, its cost basis resets to its market value. Your heirs can sell it immediately with no taxable gain.

So if you defer a gain and hold the position for the rest of your life, the tax isn't just delayed.

It disappears.

How Does a Portfolio Generate Losses When the Market Goes Up?

Most people assume that when the stock market returns 10%, every stock goes up about 10%.

That's not how it works.

Research from an Arizona State University professor found that only about 4% of stocks have generated the entire net gain of the stock market.

In any given year, many stocks in a diversified portfolio lose money, even when the market is up.

Tax-aware investing sells the losers to realize the losses, and replaces them with similar (but not identical) stocks so you stay invested. It holds the winners so their gains stay unrealized and keep compounding.

Table 2: Harvesting Losses While Staying Invested

The portfolio earns the same 10% as an index fund. But you also get a $50,000 realized loss to offset your business sale gain, while the $150,000 gain keeps growing untaxed until step-up in basis wipes it out.

How Does Borrowing Make This Strategy More Powerful?

As we covered in our article, "Borrowing Against Your Portfolio," borrowing against your portfolio turns the interest into a tax deduction.

Tax-aware investing uses that same leverage to generate even more losses.

Here's the same $1 million portfolio with another $1 million borrowed against it at 4.5%:

Table 3: Tax-Aware Investing With and Without Leverage

With leverage, your deductions nearly triple to $145,000 and your net gain rises from $100,000 to $155,000, as long as your portfolio earns more than your cost of borrowing.

The right amount of leverage depends on three things:

1. How large is the capital gain you need to offset?
2. How much extra return do you expect from the strategy?
3. How much confidence do you have in the manager's ability to pick winners and losers?

Who This Strategy Is Best For

• ✓Business owners preparing for an exit
• ✓Investors selling highly appreciated stock
• ✓Individuals anticipating a large capital gain
• ✓Entrepreneurs planning for retirement
• ✓Families looking to preserve wealth after a major liquidity event