qualify the exchange and trigger an immediate capital gains tax.“ This is not a‘ gray area’ strategy,” he says.“ It must be executed precisely.”
Section 351 exchanges aren’ t new— they actually predate the creation of ETFs. They were originally designed to let business owners put appreciated assets into their company in exchange for company stock without triggering a taxable event. To remain untaxed, the business owner had to possess at least 80 % of the corporation after the transaction. The idea was to promote capital investments
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.
in businesses and thus strengthen corporate formation.
Only recently, however, has this notion been applied to individual investment portfolios. For many savers, a section 351 exchange may seem ideal for improving portfolio diversity and deferring taxes. And tempting offers from ETF companies make these exchanges easier. Some ETF sponsors, for instance, have special services designed to help clients launch new ETFs that meet the IRS requirements.
No matter how desirable these comeons may sound, though, experts stress the need for caution.
Don’ t forget that ETFs have an embedded expense ratio, they say.“ The firms managing them are locking in a fee stream, as investors are likely to hold these products for a relatively long time,” says Matthew Garrott, director of investment research at Fairway Wealth Management in Independence, Ohio.“ Typically, fees for the funds aren’ t outrageous, but the position sizes and time horizons make them an enticing product for fund managers.”
Another wrinkle, he says, is that some popular stocks may not be immediately accepted by ETF managers, particularly if there is“ a backlog of investors in the same position, all looking to contribute to a fund.” Consequently, he explains, it could take months to prepare and launch the desired target ETF.
There is also a scant possibility that the ETF could close one day— for instance, if the fund managers decided they had to liquidate. This would force clients into the taxable event they had sought to avoid.
Alternatives
To be sure, there are other ways besides 351 exchanges that investors can circumvent capital gains taxes. Clients who want to give to charity can donate appreciated assets, a move that’ s not only tax-exempt but can possibly win the clients a tax deduction: To qualify as deductible, the charity must be a 501( c)( 3) organization, the client must itemize deductions on Schedule A of the federal tax return, and as of 2026 the donation must exceed 0.5 % of the client’ s adjusted gross income.
Another way for clients to avert an upfront capital gains tax on their assets is to simply hold on to them. Their portfolios might be unbalanced during their lifetime, but after they die their heirs will inherit those assets with an automatic step-up in basis, meaning that if the heirs sell the assets later, the capital gain will be much less.
Of course, clients don’ t need to choose one of these options over the others, advisors say. Highly concentrated assets can be parceled out piecemeal among any or all these strategies.“ The answer doesn’ t have to be binary,” Hasan says.“ Highly appreciated assets often involve strong emotional attachment and behavioral biases, [ and divvying up the assets ] can help clients feel more in control.”
The ideal plan for any particular client could include donating a portion of their total assets, executing a section 351 exchange for another portion and holding on to others for a step-up in basis for heirs.
It’ s prudent to“ pursue multiple avenues when managing a portfolio that has a concentrated equity position,” says Ryan Smith, director of public markets at Caprock in Livingston, N. J.“ Therefore, charitable donations and 351 exchanges may be used in tandem as part of a broader continuum of investment strategies.”
All in all, advisors say that clients should not rush into a section 351 exchange. Realize that once completed, it cannot be undone.“ It is effectively a one-way transaction,” says Sachs.“ That permanence must be clearly understood.”
MARCH / APRIL 2026 | FINANCIAL ADVISOR MAGAZINE | 51