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Exchange Fund

Sophisticated diversification method for holders of large single-stock positions. Use of these instruments allows concentrated shareholders who desire diversification to get it without the capital gains that result from selling the stock. Investment is made by contributing acceptable securities (not stock options) to the fund in a tax-free exchange for interests in the diversified pool of other stock. You thus keep your original tax basis in the securities.

The fund, which is usually a limited partnership, includes securities contributed/exchanged by others with similar needs and quality stock holdings. The fund is a private placement that uses exemptions from registration from both the Securities Act of 1933 and the Investment Company Act of 1940, so it is available only for accredited investors. Sponsors of these instruments include large mutual-fund companies and brokerages.

Alert: IRC Sec. 424(c) lists as a disqualifying disposition any exchange of stock as a disposition. A contribution of ISO stock to an exchange fund could be treated as an exchange for ISO tax purposes.
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