The 351 ETF exchange.
INTERNAL REVENUE CODE §351 · ETF CONVERSION
Diversify without triggering the gain.
Contribute an appreciated portfolio in kind to a newly launched ETF and receive fund shares instead of a tax bill.
How a 351 exchange works
Section 351 of the tax code lets you transfer property to a corporation in exchange for its stock without recognizing gain. An ETF is a corporation for tax purposes, so an appreciated portfolio can be contributed in kind at the fund's launch: nothing is sold, nothing is realized, and your cost basis carries over into the ETF shares you receive.
What changes is what you own. A legacy portfolio of individual holdings becomes a share of a diversified, professionally managed fund — and inside that fund, the ETF's in-kind creation and redemption mechanism does the ongoing work of managing your low-basis tax-lots.
Exchange funds reach the same outcome by a different route: your concentrated position is pooled with other investors' holdings, again without a sale, in exchange for a partnership interest. The trade is time and structure — typically a seven-year hold, plus a ~20% real-estate allocation purchased with borrowing to meet the fund's requirements — where a 351 exchange leaves you holding an ordinary, liquid, marginable and tradable ETF.
What decides whether it fits
The pool has to be diversified. The securities going in — across all contributors together — must broadly satisfy the tax code's diversification tests: no more than 25% in any single issuer, and no more than 50% in the largest five. A single concentrated position generally cannot go in on its own.
There is a window, not a door. A 351 exchange happens at a fund's launch or during a defined contribution window. It is a scheduled event, so the timeline belongs in your planning rather than the other way round.
Deferral, not forgiveness. Nothing is sold, so nothing is realized — your basis carries over into the ETF shares. The gain comes due when you sell those shares; under current law a step-up at death still applies.
Swap tax-lot for tax-lot. Inside the ETF you own fund shares. Lot-level accounting does not go away: Schwab matches individual lot-level records through the exchange, so each contributed lot's basis and holding period carries into the ETF shares it became — and specific low-basis lots stay identifiable, for gifting or for when you eventually sell.
Not everything qualifies. Mutual funds, closed-end funds (CEFs), restricted, pledged, illiquid or non-transferable holdings — and most derivatives — generally can't be contributed. Retirement accounts get no benefit.
General information about how the exchange works — not tax or legal advice. Eligibility depends on the fund and on the full pool of contributed securities; confirm your own situation with your tax advisor.
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