For most people holding $1 million of low-basis shares, Edward Jones Investments favors selling stock in stages over an exchange fund: the fund defers the gain but locks money up for about 7 years. Quick test: if you may need any of the money within 7 years, or your investments total less than about $5 million (the qualified purchaser line many funds use), the exchange fund usually drops out of the comparison.
We wrote this for tech employees who hold $1 million or more in one company's stock bought at a small basis, often their current or former employer after an IPO. If you already have well over $5 million invested and no cash needs for a decade, you can skim the tax math and read the section on newer ETF exchanges. Edward Jones Investments hears these questions in first meetings, where a relative's choice often gets copied into a very different household.
Don't copy a relative's exchange fund
Copying a relative's exchange fund decision ignores the 2 facts that made it work for him. Take Fatima's brother-in-law (hypothetical): he put his stock into a fund with $6 million in investments and no cash needs for 10 years. Fatima has $1 million of stock and a baby due. Copying him would lock away the cushion for childcare and a house.
The trap is in the exit. Leaving before about 7 years typically returns the shares originally contributed, not the diversified basket. An exit in year 3 puts her back in one stock and leaves her with the fund's costs already paid. That's a bit like breaking a car lease early and still owing the payments.
You can catch this before it costs anything. Ask the sponsor for 2 pages before anything else: the eligibility requirements and the early-redemption terms. Then lay them next to your own cash needs for the next 7 years, year by year.
What does diversifying $1 million of stock cost each way?
Selling everything in 1 year costs about $190,400 in tax on an $800,000 gain at an assumed 23.8%, while an exchange fund costs $0 at contribution but locks the money for about 7 years. A staged sale falls between them: tax arrives each year, cash is available each year, and unsold shares stay concentrated.
The exchange fund defers the whole gain, but your original basis follows you into the fund, so the $800,000 gain is waiting whenever you sell what comes out. The one-year sale uses 23.8% (20% long-term rate plus 3.8% net investment income tax) and ends your exposure the same day. The staged sale spreads the same tax over several years and keeps part of the position at risk while it runs. Every investment carries the risk of loss, including the money you started with, and a concentrated stock can fall sharply in any year.
| Option | Tax due now | Years locked up | Diversification | Access to cash |
|---|---|---|---|---|
| Exchange fund | $0 | About 7 | Basket at the end | None until exit |
| Staged sale | Paid each year | 0 | Grows with each sale | Every year |
| Sell all in 1 year | $190,400 | 0 | Complete, same day | Immediate |
Wait for the ISO holding date before choosing
Fatima (hypothetical, round numbers) is 34, a staff data scientist who moved from a late-stage private software company to a public one. She's married to an ER nurse, and they're expecting their first child. After her former employer's IPO, her exercised shares are worth $1 million with a $200,000 basis, so her total gain is $800,000.
The position splits in two. She holds $700,000 of ISO shares with a $40,000 basis, and $300,000 of NSO shares, held over a year, with a $160,000 basis. The ISO shares reach 1 year from exercise in 2 months. Selling earlier would make the $300,000 exercise spread ordinary income instead of long-term gain.
An exchange fund would defer the whole $800,000, but she lacks the $5 million many funds require, and she'll need cash within 7 years. So she sells the NSO shares now: $300,000 minus $160,000 basis is a $140,000 gain, and 23.8% of that is about $33,320.
After the date she sells the ISO shares in stages. That's $700,000 minus $40,000, a $660,000 gain, and 23.8% of it is about $157,080. Add them: $33,320 + $157,080 = $190,400, the same total as the one-year sale, paid over time and with cash arriving each year.
Before contributing ISO shares to any fund early, ask the CPA whether the contribution counts as a disposition. AMT credits from the ISO exercise have their own page and aren't covered here.
Did newer ETF exchanges change the exchange fund math?
Section 351 exchanges into newly launched ETFs have spread as a tax-deferred way to swap holdings, which changes the answer for some people who were told an exchange fund was their only route. The catch is that the contributed portfolio must already be diversified.
No single stock can exceed 25% of the contribution, and the top 5 holdings together must stay under 50%. One employer's stock doesn't qualify. Some exchange funds now also accept accredited investors instead of only qualified purchasers, so a playbook written earlier that ruled the fund out on eligibility alone deserves a second check. The 7-year lock still applies.
The table sets 5 common beliefs next to what the rules actually say. For a $1 million single-stock position like Fatima's, each belief breaks somewhere, from the $5 million eligibility line to the 25% cap on any one stock.
| Common belief | What the rule says | What it means for you |
|---|---|---|
| The fund erases the gain | Basis carries over to the basket | The $800,000 gain waits until year 7 |
| $1 million gets you in | Many funds require about $5 million | Check eligibility first |
| You can leave for cash | Early exit returns your original shares | Keep 7-year cash needs outside |
| Selling means one huge bill | Tax falls in each sale year | $33,320 now, $157,080 later |
| ETF exchanges take one stock | No stock over 25% allowed | Single-stock positions don't qualify |
How does each route land on a spouse or heirs?
A staged sale leaves heirs diversified cash and shares with a higher basis. Exchange fund units keep your low carried-over basis while you hold them or give them away. At death, inherited assets, including fund units, generally receive a stepped-up basis. How that step-up reaches the stocks inside the partnership depends on the fund's elections, so ask the sponsor.
Fatima's spouse, an ER nurse with a steady income, is the household's risk capacity. His paycheck covers part of spending, which affects how fast she has to sell. A fund lock ties up money the 2 of them share. Before Edward Jones Investments compares the options, it writes the household's 7-year cash needs next to each one, because a 50% drop in money you need within those years is the loss the portfolio can't afford.
Decide in 6 steps. First, pull Form 3921 and the lot-level basis. Second, mark each lot's 1-year date. Third, write down cash needs by year for 7 years. Fourth, check exchange fund eligibility. Fifth, have a CPA price the staged sale year by year. Sixth, choose, then set the estimated tax payments, which are due April 15, June 15, September 15 and January 15.
A completed sale can't be undone, and the gain belongs to that tax year. A staged-sale schedule can usually change at any time. If you sell through a 10b5-1 plan, for example because you are still an insider at the issuer, changing the plan starts a new cooling-off period. Exchange fund subscriptions can sometimes be withdrawn before the fund closes (check the offering documents for the exact due date). After closing, leaving early generally returns your original shares.
- Basis for every lot (brokerage cost basis report)
- Grant and exercise dates from Form 3921
- Cash needs over the next 7 years, in dollars
- Total investments compared with $5 million
- IPO lockup end date or next trading window
Do the eligibility check yourself; bring the tax math to Edward Jones Investments
You can pull the forms, mark the holding dates and confirm eligibility on your own. Edward Jones Investments can work through three questions with you, by video or phone for clients nationwide: the order of sales across tax years, the ISO dates and whether a 7-year lock fits your cash needs. We'll tell you what that work costs when we first talk, and we'll put the fee on paper before any work begins. A staged sale does leave unsold shares concentrated while it runs, so a sharp drop in year 1 still hurts.
What people ask about exchange fund vs. selling stock
Can I pull my shares out of an exchange fund in year 3 if we need a down payment?
Usually not in the form you contributed. Leaving a fund before about 7 years typically returns the shares you originally put in, not a slice of the diversified basket. You'd be back in one stock, and you'd have paid the fund's costs along the way. Cash needed within 7 years belongs outside the fund.
If I sell part of my shares in May, when is the tax on that gain actually due?
The tax on a May sale isn't due with your return alone. The IRS expects estimated payments by the quarterly due dates: April 15, June 15, September 15 and January 15. A May sale usually falls into the June 15 payment. A CPA can check whether withholding already covers it.
My brokerage sent me an exchange fund private placement memorandum; which pages should I read first?
Read the eligibility requirements and the early-redemption terms first, 2 pages in total. They tell you whether you qualify and what happens to your shares if you leave before about 7 years. Then compare both against your own cash needs for the next 7 years, in dollars.
Which tax forms show my basis and holding dates for exercised options?
Your brokerage cost basis report shows the lot-level basis for shares you sold or hold. Form 3921 reports ISO exercises and gives the grant and exercise dates. Pull both before comparing options, since the 1-year date and the basis for each lot drive how much tax each sale creates.
Can I swap one stock into an ETF without paying tax?
Yes, a Section 351 exchange into a newly launched ETF is one route, but the contributed portfolio must already be diversified. No single stock can exceed 25% of it, and the top 5 holdings must stay under 50%. One employer's stock alone doesn't qualify, so it rarely solves this problem.
When does an exchange fund make more sense than selling?
An exchange fund can fit someone with well over $5 million invested, no cash needs for a decade and a plan to hold until death. The lock of about 7 years is tolerable for that person, and the deferred gain may matter more than liquidity. For a $1 million position, it rarely fits.
Official references
Related reading from Edward Jones Investments
This material is general information only and does not address any individual's investment, tax or legal situation. Investing involves risk, including possible loss of principal. Before acting on any information here, speak with a financial advisor, tax professional or attorney about your circumstances.