The 351 ETF exchange.
SECTION 351 EXCHANGE
Move appreciated holdings into an ETF without selling them.
Contribute an appreciated portfolio in kind to a newly launched ETF and receive fund shares, with the gain deferred when the exchange qualifies.
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The exchange in three steps
- Your holdings. An appreciated portfolio of securities, carrying gains you have not realized.
- Contributed in kind. At the fund's launch or in its contribution window. Nothing is sold, so no gain is recognized.
- ETF shares. A diversified, tradable fund — with your cost basis generally carried over into the new shares.
How a 351 ETF 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, no gain is recognized, and your cost basis carries over into the ETF shares you receive.
After the exchange, you own shares of the ETF instead of individual holdings: a share of a diversified, professionally managed fund. Your deferred gain stays with those shares until you sell them.
How an exchange fund compares
Seven-year hold; 20% of assets in debt-financed real estate.
Exchange funds also defer the gain without a sale, by a different route: your concentrated position is pooled with other investors’ holdings in exchange for a partnership interest. The trade-offs are time and structure. You typically hold for seven years, and to meet a tax test the fund keeps at least 20% of its assets in real estate, usually bought with borrowed money: at least $25 of property, and about as much debt, for every $100 of stock contributed.
A 351 exchange instead leaves you holding an ordinary ETF that is liquid, marginable and tradable.
What decides whether it fits
What you contribute has to be diversified. The securities you contribute 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 be contributed on its own.
The largest issuer fits in a quarter: at most 25% of what you contribute. The five largest fit in half: at most 50%, combined.
The 25/50 test, on three example contributions
| Example | Largest issuer (max 25%) | Five largest combined (max 50%) | Result |
|---|
| Twenty issuers, none above 9% | 9% | 36% | Passes both tests |
| One concentrated stock at 40% | 40% | 59% | Fails both tests |
| Four positions at 15%, each under the 25% max | 15% | 64% | Fails the top-five test |
Illustration only; not tax advice. Percentages are of the market value you contribute, counted by issuer: a company's share classes and bonds count together, and an ETF you contribute is generally counted as its underlying holdings. Cash generally doesn't count toward the total; U.S. Treasuries generally count toward the total but not as any issuer. Passing both tests is one requirement, not the only one.
You can contribute only when a fund launches. A 351 exchange is available only when a new ETF launches, or during a contribution window the fund sets around its launch. You generally can't make one into an existing ETF at a time of your choosing, so plan around the fund's dates.
The gain is deferred, not eliminated. Nothing is sold, so no gain is recognized at the exchange, and your cost basis carries over into the ETF shares. The deferred gain comes due when you sell those shares. Under current law, a step-up in basis at death still applies.
A fully transparent exchange. You can expect Schwab to match 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 tax benefit.
What the IRS is watching. In September 2026 the IRS issued Revenue Ruling 2026-20 and Notice 2026-62 on what it calls “section 351 conversion transactions.” Under the ruling, if a fund, as part of the same plan, uses your contributed securities to redeem shares held by a market maker (an authorized participant) and ends up holding a materially different portfolio, you are treated as having exchanged those securities in a taxable transaction, even if your contribution passed the diversification tests. The notice takes no position on a new ETF seeded with securities that fit its strategy and that it intends to keep. Further guidance may follow.
General information about how the exchange works — not tax or legal advice. Eligibility depends on the fund and on the securities you contribute; confirm your own situation with your tax advisor.
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