i’ve never seen one of these in use and I guess i don’t understand why anyone would want to use this vehicle. i know i’m missing something here… one investor has low basis stock and must find another investor who wants to buy this stock and they then lock themselves up for a minimum of 7 years? where is the benefit in this?? there you have it folks, the first stupid post from cfasf1. feels good to be back.
I believe the idea is that a bunch of folks who each own a large block of low-basis stock in a single company (each person’s block being shares in a different company) pool their holdings and each receive an interest in the pool in exchange for their particular block of stock. I think the idea is to diversify without taking a large tax hit (as you would if you sold a large block of low-basis stock in order to buy a diversified portfolio). I’ve been told that the IRS has cracked down on these in the last few years and they’re not really being done anymore, but I’m not sure about that.
thanks, cap… any idea what incentive the party that wants to buy the stock has to get into this agreement?
My understanding is that, for example, one person with a large block of stock in Microsoft gets together with another with a large block of stock in Consolidated Can and a third with a large block of stock in ITT (say the three blocks are equal in value). They each exchange their respective block for a 1/3 interest in a portfolio made up of the three blocks. They each thus have less exposure to the company they held the large block of stock in but (and this is what made the arrangement attractive) they have somehow (not sure of the details) avoided the transaction being treated for tax purposes as a sale of their high-basis stock and a purchase of the other two stocks with the proceeds, thus avoiding paying capital gains tax. Regarding “the party that wants to buy the stock”, I don’t think anyone but the participants would buy an interest in the pool (or in the particular stocks being pooled), and again the participants’ motivation would be to diversify without taking a tax hit. I’m no expert in this but had it explained to me in brief outline several years ago by someone at a large brokerage that apparently arranged these. As I said, I’ve been told they’re not really done anymore but I don’t know for sure.
Also, this is all just based on a guess that this sort of arrangement is what you were talking about - not sure about that.
thanks for the explanation…appreciate it. i think i just must have spaced while I was reading because what you are describing sounded to me, at least in schweser, like a PUBLIC exchange fund. i think i’m going to have to check out the text to be clear of the difference between public and private. thanks again.
All the above explanations are correct except to say that the Capital Gain Tax is not eliminated BUT deferred for latter time. The point here is that the investor get a chance diversified without selling outright. The whole thing about low basic stock is that you do not want to have all of your eggs in one basket. Think like if you were a Bear Stear Executive who has millions of stocks of this company, then, i pretty sure you will understand faster:)
thanks for the reply. unfortunately, i actually do understand concentrated positions (too well) since i work for an investment bank (now a bank holding company) and our stock hasn’t fared well during the crisis. and i hadn’t diversified as much as would have seemed prudent in hindsight. (luckily, it wasn’t that much stock to start with) i guess what i was really getting at was the mechanics behind Private exchange funds. the public exchange funds make sense. but in a private exchange fund, there is one position. one party brings a low basis postion and matches up with another party who bought the same stock at current mkt prices. they then engage in hedging activity. i guess the question i had was why the hell would the party who buys the stock at current mkt prices agree to lock themselves up for 7 yrs so they can engage in hedging activity. doesn’t make sense. that is probably why the irs is cracking down on these. not sure.
See the 2007 exam, question 2-A to have a clear idea fow CfAI address this reading. Since you are fully understand the low-basis stock. Hopefully this help.
cfasf1 Why don’t you confirm for me reading 20 since you already registered. Please see my thread about this article.
thanks for your help. i didn’t mean to come off like a douche. i clearly don’t understand it fully… i will take a look at the 2007 exam question.
i will when i have my books in front of me. i’m “working”.