A 351 exchange, governed by Section 351 ETF Exchange of the Internal Revenue Code, allows a select group of investors to contribute highly appreciated, concentrated portfolios into a newly formed ETF. In return, they receive shares of the new ETF, all without triggering an immediate capital gains tax. This process is a game-changer for investors who want to diversify their holdings without facing a steep tax bill.

The Core Rules of a 351 Exchange

To participate in a 351 exchange, the ETF must meet strict diversification rules. These rules are in place to ensure the fund remains a bona fide diversified investment vehicle.

Diversification Requirements

The most critical rule is based on the individual basket of securities that each investor contributes. The ETF issuer will look at each contributed portfolio and ensure it meets two key criteria:

• The largest single position in the contributed basket cannot exceed 25% of the total market value.
• The top five largest positions in the contributed basket cannot exceed 50% of the total market value.

Since an ETF is considered on a “look-through” basis, our software will evaluate the individual securities within any ETFs you contribute to ensure the entire basket meets these rules.

Liquidity

The securities you contribute must be liquid. This means you can exchange a wide range of assets, including stocks, other ETFs, bonds, and closed-end funds—anything that can be traded intra-day. Cash, however, cannot be part of the contribution.

Investment Thesis Alignment

Your contributed securities must align with the investment thesis of the new ETF. For example, if the fund is focused on emerging markets, you wouldn’t be able to contribute US large-cap growth stocks. However, for actively managed funds, the rules are often more flexible, allowing for a broader range of contributed assets.

How ExchangiFi Helps

ExchangiFi is a platform that connects investors and advisors with ETF issuers to facilitate these tax-deferred exchanges. Our platform streamlines the entire process, from initial analysis to the final exchange.

• Portfolio Analysis: Our proprietary software allows you to upload your portfolio and instantly see if it meets the diversification requirements. The tool will calculate the potential capital gains tax deferral amount and the total market value of your contributed basket. Since our platform is plugged into live market data, you can be confident that the values are accurate and up-to-the-minute.
• Deal Flow: The ExchangiFi dashboard provides a centralized view of all live 351 exchange opportunities. You can see newly formed ETFs that are approved by the SEC but haven’t launched yet. This is your only chance to participate, as a 351 exchange must happen before the ETF’s official launch.
• Advisor-Friendly: Our platform is designed with advisors in mind, allowing them to easily manage client accounts and create separate portfolio conversion plans. This helps ensure a seamless transition for clients who would benefit from a 351 exchange.

The Outcome: Post-Exchange Benefits

Once the securities are transferred and the new ETF is launched, you will receive shares of the fund in your brokerage account. At this point, the new ETF shares are fully liquid and can be sold at any time.

Crucially, the original tax lot information is preserved. The acquisition date and cost basis of your new ETF shares will be the same as the original securities you contributed, which means there’s no step-up in cost basis. The new shares simply take on the historical tax attributes of your old shares, deferring the tax liability until you eventually sell the ETF.

Ready to explore how a 351 exchange can unlock diversification and tax efficiency for your portfolio? Reach out to us today or log in to the platform to see the live deals listed on our dashboard.