Diversifying a Concentrated Position: When Tax Deferral May be Possible

For investors with a large position in a single stock, diversification is often easier said than done. Over time, a concentrated holding, whether from early investment, equity compensation, or business ownership, can grow into a significant portion of overall wealth.

At that point, the need to diversify becomes clear but there’s a catch. Selling those shares may trigger a substantial capital gain, and with it, a meaningful tax bill.

It’s a common dilemma and while there is no simple way to swap one investment for another without tax, there are more advanced strategies that may allow investors to defer tax while achieving diversification in the right circumstances.

Why diversification can be complicated

In most cases, moving from one investment to another is straightforward. An investor sells the existing position, realizes any gain or loss, and reinvests the proceeds elsewhere.

From a tax perspective, the issue arises at the point of sale. If the shares have appreciated significantly, selling them triggers a capital gain immediately, even if the intent is simply to reinvest in a more diversified portfolio. For investors with highly concentrated positions, that tax cost can become a barrier to making a change, leaving them exposed to the risks of holding a single stock.

A more advanced approach

In certain situations, it may be possible to transfer shares into a professionally managed investment structure in a way that defers the immediate tax impact.

These strategies are typically facilitated by specialized third-party firms and are not available through standard brokerage accounts. They often involve transferring an existing position into a pooled investment fund in exchange for units of that fund, rather than selling the shares outright.

From the investor’s perspective, the result is a shift from a concentrated holding to a more diversified portfolio, without triggering an immediate capital gain subject to tax.

Where tax deferral comes in

The tax deferral element of these strategies is generally achieved through a specific provision of the Income Tax Act known under Section 85 by completing the T2057 Election on Disposition of Property by a Taxpayer to a Taxable Canadian Corporation form.

In simplified terms, a Section 85 election allows certain capital property such as shares, to be transferred to a corporation at an elected value (i.e., adjusted cost base) rather than fair market value. This means that, instead of realizing a capital gain at the time of transfer, the adjusted cost base can be carried forward into the new investment.

The gain is not eliminated but it is deferred. When the new investment is eventually sold, the deferred gain will need to be recognized.

What this looks like in practice

While the exact mechanics vary depending on the provider and structure, the general process follows a similar path. An investor works with an external firm that offers these types of programs to determine whether their shares are eligible and whether the strategy is appropriate for their situation. If they proceed, the shares are transferred into a fund or corporate structure, and a joint election is filed to support the rollover.

In return, the investor receives units in a diversified investment portfolio. The adjusted cost base of the original shares carries over into those new units, which is what allows the capital gain to be deferred rather than realized at the time of transfer. From the investor’s perspective, their account continues to hold an investment position, but the underlying exposure has shifted from a single stock to a broader portfolio.

Who these strategies are designed for

This type of planning is not a fit for every investor. In most cases, it is intended for individuals who:

• Hold a large, concentrated position in a single publicly traded stock
• Have significant unrealized capital gains
• Meet certain income or net-worth thresholds, often required to qualify as an accredited investor
• Are working with an external firm that offers these specialized solutions

These strategies sit firmly in the high-net-worth planning space and are typically considered alongside broader tax and investment planning decisions.

Important considerations

While the ability to defer tax and diversify at the same time can be appealing, there are important trade-offs to consider. The most important—which we’ve highlighted many times already—is that tax is deferred, not eliminated. The capital gain still exists and will be recognized when the new investment is eventually sold.

There is also a shift in how the investment is held. The original shares are exchanged for units in a pooled structure, which means the investor no longer has direct ownership of the individual stock. Depending on the structure, there may also be differences in liquidity and flexibility compared to publicly traded securities.

Another key factor is opportunity cost. By deferring the sale of the original shares through a structured exchange, the investor may be giving up the ability to redeploy capital more freely or take advantage of other investment opportunities. In some cases, the fees, constraints, or performance of the new structure may also impact overall returns compared to a more flexible approach. This makes it important to weigh the benefit of tax deferral against what may be sacrificed in terms of control, timing, and potential upside.

Finally, these transactions are typically not reversible. Once the exchange has been completed, the investor cannot simply unwind the transaction and return to their original position. As a result, careful planning and review are essential before proceeding.

Bringing it together

For investors with a concentrated stock position, the decision to diversify is often clear. The challenge is how to do so in a tax-efficient way. While there is no universal solution, strategies that combine diversification with tax deferral may be worth exploring in the right circumstances, particularly when supported by specialized external providers and coordinated with a broader tax plan.

This is a topic that continues to come up in industry conversations and professional discussions, reflecting a growing interest in how these strategies can be applied thoughtfully. It has also been part of recent discussions alongside investment professionals, highlighting how tax and investment planning often intersect in more complex scenarios.

If you are considering your options around diversification, or want to better understand how these structures might fit into your overall plan, your DMCL advisor can help you evaluate whether this type of approach makes sense for your situation.