COLLEGE PLANNING | ESTATE PLANNING | INSURANCE | INVESTING | PORTFOLIO SPOTLIGHT | REAL ESTATE | RETIREMENT | TAX PLANNING

This strategy helps investors unwind appreciated stocks. But it can get complicated. By Ben Mattlin

To rebalance to target allocations, they might need to sell off certain assets that are starting to dominate their portfolios. But doing so will trigger hefty capital gains taxes.

Some advisors have a solution: the section 351 exchange. These exchanges“ are helpful for clients who are‘ locked up’ in a low-basis position and want diversification without triggering an immediate taxable event,” says Charles Sachs, chief investment officer at Imperio Wealth Advisors in Miami.

Named after a part of the tax code, 351 exchanges let investors trade highly valued securities for a newly created exchange-traded fund that matches the assets and is structured to have the same cost basis( U. S. equities for a U. S. equity ETF, for example). The transfer itself does not generate taxes. And once the assets are in the ETF wrapper, they can be swapped for others of similar type, tax-free, thanks to the tax-efficient structure of ETFs. Subsequent investments to the fund, though, do not receive special tax treatment, and selling off the assets will activate a capital gains tax.

“ A section 351 exchange is a gain-deferral strategy— it does not eliminate the gains,” says Rafia Hasan, chief investment officer at Perigon Wealth Management in Chicago.“ Selling the ETF will still trigger realization of the deferred gains.”

Nevertheless, for clients who want to diversify a long-held portfolio without an immediate tax event, the exchange can be a perfect solution. As with any tax rule, however, several restrictions must be followed carefully and exactly, or the strategy will fail.

First, no single asset can represent more than 25 % of the total value of the transfer, and the aggregate value of the top five holdings in the transfer cannot exceed 50 % of the transfer’ s total value.

Second, the assets that the investor wishes to exchange cannot be mutual funds, private-market securities, options, REITs or crypto currencies— though they can be other ETFs.

Third, the target ETF must be similar to the original asset and must be constructed such that it preserves the original cost basis.

To some advisors, these requirements make the exchanges impractical in all but a few cases.“ They exclude a significant percentage of clients who most need diversification,” Sachs says.“ Many investors in AI-related stocks, for example, have one or two positions that dominate their portfolio. Because the IRS diversification requirements generally prevent a single holding from exceeding 25 % of contributed assets, and the top five holdings from exceeding 50 %, many concentrated investors simply don’ t qualify.”

Advisors must carefully evaluate and document every step of the transfer, he adds. Failing to meet any of the rules could dis-

50 | FINANCIAL ADVISOR MAGAZINE | MARCH / APRIL 2026 WWW. FA-MAG. COM