Treasury reviews 351 ETF exchanges amid tax planning scrutiny

The US Treasury Department is taking a hard look at one of Wall Street’s favorite tax tricks, and the findings could reshape how investors think about ETFs as tax-planning vehicles. At least 87 funds launched through Section 351 exchanges are now under review, collectively managing around $18 billion in assets.

What Section 351 exchanges actually do

Section 351 of the Internal Revenue Code allows investors to transfer appreciated securities into a newly created corporation, in this case an ETF, in exchange for shares of that fund. The key benefit: no immediate capital gains tax bill.

In English: imagine you bought a bunch of stocks years ago that have since skyrocketed in value. Selling them would trigger a massive tax hit. But contributing them to a new ETF through a Section 351 exchange lets you swap into a diversified fund while kicking the tax obligation down the road. Your cost basis carries over, meaning you only owe capital gains when you eventually sell the ETF shares.

The strategy gained serious traction starting in 2021. Strong equity markets meant investors were sitting on enormous unrealized gains, and financial advisors spotted an opportunity to pair an old tax code provision with the ETF wrapper’s inherent tax efficiency.

There are guardrails built into the process. No single contributed security can represent more than 25% of the total assets going into the fund. The top five securities combined can’t exceed 50%.

Why Treasury is concerned

Internal discussions about potential guidance on these conversions reportedly began as early as February 2026. Since then, officials have participated in at least one Wall Street Tax Association seminar where they openly questioned whether these transactions align with the spirit of the tax code.

The Investment Company Institute has met with Treasury officials at least twice to discuss clarification on Section 351 policies.

One area of concern is the potential overlap between the tax-deferral benefits of Section 351 conversions and the tax advantages that ETFs already enjoy through their in-kind creation and redemption mechanism. There’s also the question of whether certain ETF conversions might be classified as “transactions of interest,” a formal IRS designation for strategies that have potential for tax avoidance. That classification would require participants to report the transactions to the IRS, adding disclosure burdens and compliance costs.

As of late July 2026, no formal prohibitions or new regulations have been issued.

What this means for investors

If Treasury issues restrictive guidance, the pipeline of new fund launches using this strategy could dry up. Asset managers who have been racing to launch Section 351 ETFs, with at least 87 already live, would need to find alternative approaches for tax-conscious clients with concentrated stock positions.

Section 351 conversions have become a meaningful source of seed capital for new ETFs. Remove that incentive, and some asset managers may find it harder to launch products with sufficient scale to be economically viable.

For financial advisors, the message is straightforward: any client considering a Section 351 conversion should understand that the regulatory ground is shifting. A strategy that works perfectly under today’s rules might look very different under tomorrow’s.

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