Prepaid Variable Forward Contracts

The problem this solves

You hold $4 million in a single employer's stock. The cost basis is near zero — these are RSU shares that were taxed as ordinary income when they vested, so your capital gains basis is the fair market value at vesting, which may be years below today's price. An outright sale today triggers capital gains on the appreciation since vesting, plus California's 13.3% rate on top of federal rates. The tax bill could be $500K–$800K or more depending on how long you've held the shares and how much they've appreciated.

You want liquidity — perhaps for real estate, a private investment, diversification, or just the peace of mind of not having everything in one name. But you don't want to write that check yet. A PVF addresses this directly.

What "prepaid" and "variable" mean

Prepaid means you receive cash upfront — at contract initiation, not at maturity. This is what distinguishes a PVF from a standard forward contract. The counterparty (typically a major bank) pays you a percentage of the current market value of your shares immediately. You keep the shares for now — they remain in your name, pledged as collateral.

Variable refers to the settlement mechanics. At maturity, you don't simply deliver a fixed number of shares. Instead, how many shares (or how much cash) you deliver varies based on the stock's price at settlement. Typically: if the stock is below a floor price, you deliver a fixed number of shares (the counterparty absorbs the downside risk below the floor); if the stock is between the floor and a cap, you deliver fewer shares; if the stock is above the cap, you deliver a fixed number of shares again (you forgo upside above the cap). This variable structure is what allows the transaction to avoid being a constructive sale under IRC §1259.

The IRC §1259 constructive sale issue

This is the most important technical point. Under IRC §1259, certain transactions that effectively lock in a gain on appreciated financial positions are treated as "constructive sales" — meaning the IRS treats them as if you sold the stock, even though you didn't. If a PVF is structured too aggressively (too narrow a spread between floor and cap, effectively locking in the gain), it triggers §1259 and you owe tax immediately.

The "variable" feature — the meaningful spread between floor and cap — is what keeps a PVF outside the constructive sale rules. You retain real economic exposure to the stock's price movement within the range. This is not optional structure — it is legally required. Every PVF must be reviewed by tax counsel to confirm §1259 compliance before execution.

What you retain and what you give up

Upside above the cap: given up. If the stock doubles between now and settlement, you deliver a fixed number of shares at the cap price — you don't participate in the appreciation above the cap. This is the economic cost of the upfront cash and the deferral.

Downside below the floor: protected. If the stock falls below the floor, you deliver a fixed number of shares and the counterparty absorbs the additional decline. This is a meaningful economic benefit — you're partially hedged against a catastrophic decline during the contract period.

Dividends, if any, typically continue to be paid to you during the contract period (details vary by counterparty and structure).

Who this is appropriate for

PVFs work best for investors who have a large, concentrated, single-stock position (typically $2M or more), a meaningful unrealized capital gain, a genuine near-term liquidity need, and a plan for what happens at settlement — including how to manage the tax event in the settlement year. They are not appropriate for small positions, short time horizons, or situations where the investor expects to need to sell the shares before settlement.