Understanding Section 351 ETF Conversions
Section 351 of the Internal Revenue Code allows investors to contribute appreciated securities into a newly formed ETF — without triggering a taxable event. Your cost basis carries over. Your holding period carries over. And you gain immediate liquidity through publicly traded ETF shares.
Check If Your Portfolio QualifiesWhat is a 351 exchange?
Section 351 of the Internal Revenue Code allows investors to contribute appreciated property — stocks, ETFs, and other securities — to a newly formed corporation in a tax-free exchange, provided the contributors collectively own at least 80% of the new entity after the transaction.
In the context of ETF conversions, the new entity is a Registered Investment Company (RIC) — the same legal structure as any public ETF. You transfer a diversified portfolio of securities into the new ETF and receive shares in return, without recognizing any capital gains. Your original cost basis and holding period carry over to the ETF shares you receive.
The seed window — the period during which portfolios are submitted and assembled — is typically 2–3 months before the ETF launches. 351 ETFs tend to employ active strategies with broad mandates, which allows the fund manager to accept a wider variety of contributed securities. Once the ETF launches, it trades on a public exchange and uses the standard in-kind creation/redemption mechanism for ongoing portfolio management.
The general rule of thumb is “diversified to diversified” — your portfolio must meet the 25/50 diversification test at the time of contribution. However, investors with concentrated positions can often participate with some adjustments, such as trimming overweight positions or strategically adding to other holdings before submitting. A portfolio qualification tool can help identify what changes, if any, are needed.
Who is a 351 exchange designed for?
While the ideal portfolio is already diversified, investors with concentrated positions can often qualify with some adjustments. Here are the most common scenarios.
SMA investors with embedded gains
Your separately managed account is "locked up" — tax-loss harvesting opportunities are exhausted, and rebalancing would trigger a large tax bill. A 351 exchange lets you transition to an ETF without realizing those gains. This is the most common use case.
Concentrated position holders
Your shares vested at $350,000 and are now worth $1,000,000. While the portfolio must meet the 25/50 diversification test, concentrated positions can often be made eligible with some adjustments — such as trimming overweight holdings or adding complementary positions before contributing.
Multi-stock portfolios that have outgrown their structure
You hold 20, 50, or 100+ individual stocks across brokerages. Managing it is complex, and the appreciated positions make consolidation prohibitively expensive from a tax perspective. A 351 conversion simplifies everything into a single, professionally managed ETF.
Estate planning with step-up in basis
If held until death, ETF shares receive a step-up in cost basis under current tax law — effectively eliminating the embedded capital gain for your heirs. Whether held for one year or thirty, the step-up applies, making this a powerful multigenerational wealth strategy.
How it works
Seed
During a 2–3 month seed window, you contribute a diversified portfolio of appreciated securities to a newly formed ETF. Fund managers assemble the portfolio to meet SEC and diversification requirements.
Exchange
On launch day, the ETF begins trading on a public exchange. Your contributed securities are exchanged for ETF shares — your cost basis and holding period carry over with no taxable event.
Hold or Sell
ETF shares appear in your account and are immediately tradable. The ETF handles ongoing rebalancing through in-kind redemptions with authorized participants. Sell whenever you choose — or hold for a step-up in basis.
Why investors choose a 351 exchange
No Taxable Event
Your contribution is not a taxable event. Zero capital gains are recognized at the time of exchange — you only pay taxes if and when you choose to sell your ETF shares, giving you complete control over timing.
Immediate Liquidity
ETF shares trade on a public exchange from the first trading day. No 7-year lockup, no redemption gates, no early withdrawal penalties. Need emergency access? Just sell your shares like any other ETF.
Cost Basis & Holding Period Carry Over
Your original cost basis and holding period of the converted assets transfer directly to the ETF shares you receive. Tax lot information is sent to your broker — nothing is lost in the transition.
Tax-Efficient Portfolio Management
The ETF coordinates with authorized participants to handle in-kind redemptions and portfolio rebalancing — without triggering taxable events for shareholders. This structural advantage is impossible in an SMA.
No Illiquid Asset Requirements
Exchange funds must hold 20% in illiquid assets like real estate. A 351 ETF is a diversified basket of securities tracking the investment objective — fully transparent, fully liquid from day one.
Open to the General Public
Exchange funds typically require qualified purchaser or accredited investor status. Section 351 ETF conversions are generally open to all U.S. investors — the entity meets Registered Investment Company requirements.
Requirements & qualification
A 351 exchange is not for everyone. Your portfolio must meet specific diversification tests, and certain account types are required. Here's what to know.
The 25/50 diversification rule
To qualify under Section 351, your contributed portfolio must already be well-diversified. Two IRS tests must be satisfied at the time of contribution:
Single Position Limit
No single security can represent more than 25% of the total value of your contributed portfolio.
Top Five Holdings Limit
Your five largest positions combined cannot exceed 50% of the total portfolio value.
If your portfolio doesn't currently meet these thresholds, you may be able to make adjustments — such as trimming overweight positions — before submitting. A portfolio qualification tool can test eligibility before you commit.
Eligible account types
Section 351 exchanges are generally available to U.S. persons across a range of account structures.
How a 351 exchange unfolds
From portfolio submission to ETF launch — a typical timeline for the Section 351 conversion process.
- Submit your portfolio through the 351 software portal
- Review and sign the Summary Transfer Agreement confirming positions, dollar values, and terms
- Transfer Agreement is finalized between all parties
- Trading freeze begins — contributed securities cannot be bought or sold
- Final document review and compliance checks are conducted
- Broker statements uploaded to the portal
- Securities physically transferred to the fund custodian
- Final diversification testing completed
- Fund NAV is calculated and submitted to the exchange
- ETF begins public trading on the exchange
- ETF shares delivered to your brokerage account (typically within 1–2 business days)
- Cost basis and tax lot information sent to your broker
Does your portfolio qualify?
Our 351 Portfolio Optimizer instantly tests whether your holdings meet the diversification requirements for a Section 351 ETF conversion — and shows you exactly what changes are needed if they don't.
Check Your PortfolioWhat you'll get
- Upload your portfolio or enter holdings manually
- Instant 25/50 diversification test results
- See exactly what adjustments are needed to qualify
- No account required — completely free
Frequently asked questions
Common questions about Section 351 ETF conversions.
NOT FDIC INSURED – MAY LOSE VALUE – NO BANK GUARANTEE – FOR FINANCIAL PROFESSIONALS
For illustrative purposes only and not indicative of performance that has been or is likely to be produced by Brandywine. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. THERE IS THE RISK OF LOSS AS WELL AS THE OPPORTUNITY FOR GAIN WHEN INVESTING WITH BRANDYWINE. This communication is provided for informational purposes only and does not constitute an offer to sell or the solicitation of an offer to buy any security.
A registration statement relating to these securities has been filed with the U.S. Securities and Exchange Commission but has not yet become effective. The securities may not be sold, nor may offers to buy be accepted, prior to the time the registration statement becomes effective.
Any discussion of a Section 351 exchange is for general informational purposes only and does not constitute tax or legal advice. Eligibility and tax treatment depend on individual circumstances. Investors should consult their own tax and legal advisors.