A Guide to 351 Exchanges

Some fit your current strategy. Others don’t, but you keep them because selling would come with a steep tax bill. And paying those taxes can feel like a setback after years of diligent saving and investing. 

Section 351 of the Internal Revenue Code (IRC) can help “clean house.”  

It’s not a loophole or gimmick. It’s a legitimate, IRS-recognized exchange that’s starting to gain traction in 2025. So, if you’re looking for flexible ways to manage concentrated positions without triggering unnecessary capital gains, you might be in luck.   

Let’s explore how these exchanges work, the tax benefits, who may benefit most, and how to decide if one could make sense for your situation. 

The tax code is a massive rulebook: dense, dry, and for 99% of the population, not worth reading cover to cover. Yet, tucked deep inside its nearly 7,000 pages are useful maneuvers like 351 exchanges.  

A 351 exchange is a tax-deferred transfer of appreciated assets — such as your company’s stock or other securities — into a newly created exchange-traded fund (ETF). Under Section 351 of the IRC, you, the transferor, can contribute securities and receive shares of a new investment company, typically a diversified ETF. 

Why go through this administrative effort? You don’t recognize capital gains at the time of the exchange. Instead, your original cost basis carries over to the new shares, allowing you to defer taxes until you eventually sell. This means you can reposition your portfolio without the tax hit.  

If this sounds familiar, it’s because the concept mirrors a 1031 exchange in real estate. Property investors have long used 1031 rules to roll gains from one property into another, tax-deferred. Section 351 applies the same principle to securities you already own (instead of real estate). 

Why the sudden buzz now? Two reasons.  

1. First, the mechanics are more feasible today thanks to advances in fund seeding and compliance technology. Asset managers are launching ETFs at a faster pace, giving individual investors more opportunities to participate in these exchanges — typically through advisors who can access new fund launches before they become widely available. 

2. Second, after almost two decades of strong stock market performance since the financial crisis, many long-term investors are sitting on huge, embedded gains. 351 exchanges can be a timely way to unlock diversification without triggering a hefty tax liability. 

Key Diversification Rules 

To qualify for tax deferral under Section 351, your contribution must meet certain diversification requirements set by the IRS: 

• No single security can exceed 25% of the total contribution. 

• The top five securities together cannot exceed 50% of the contribution. 

So, you can’t hand over one giant stock position and expect to come away with a diversified ETF. You’ll need a mix of securities, typically other stocks and ETFs, to meet the requirements.  

Keep in mind that not every asset qualifies — mutual funds, REITs, and other alternatives generally can’t be exchanged this way. Your advisor can help confirm whether your holdings meet the criteria.

Benefits of a 351 Exchange 

Structured properly, 351 exchanges can give you several advantages: 

• Instant diversification: Exchange a concentrated position for a broad ETF. 

• Tax deferral: No taxable event at the time of exchange; your cost basis carries forward. 

• No lockups: Unlike exchange funds, there isn’t a seven-year holding period. 

• Cleaner tax reporting: You avoid complicated K-1s and instead receive 1099 reporting. 
• Dividend continuity: You continue to receive dividends from the ETF, unlike some alternative structures that restrict cash flow. 

The result is a fairly seamless way to transform a risky, single-stock position into a more balanced portfolio — sans the immediate drag of capital gains taxes. It’s a rare chance to improve your portfolio’s health without sacrificing tax efficiency.

Regardless of the root cause, there’s ample empirical evidence that concentrated positions magnify risk. Between 1980 and 2020, a concentrated position underperformed the market about 67% of the time. In fact, around 40% of the time, a single stock generated absolute negative returns — which means a cash position would’ve been more profitable.  

On the other hand, another study found that a mere 4% of companies were responsible for the net gains of the entire US stock market from 1926 to 2018. In other words, it’s very, very difficult to pinpoint the companies that will drive the economy (and your portfolio) onward and upward.  

The dangers of concentration are not only volatility and opportunity cost but also looming tax consequences. Consider this scenario: 

• You’ve accumulated $1 million in a single stock, with a cost basis of $400,000. 

• You’d like to rebalance your portfolio to better align with your financial plan — or perhaps to free up some liquidity for a major purchase or upcoming life goal. 

• Selling outright would trigger $600,000 in capital gains and saddle you with a six-figure tax bill, effectively penalizing you for trying to make a prudent decision. 

• With a 351 exchange, you could transfer a portion of that stock (along with other holdings to meet diversification rules) into a new ETF. 

As a result, your ETF conversion defers your taxable gain and better diversifies your portfolio.

Separately Managed Accounts (SMAs) 

An SMA is like an ETF for one investor — a customized portfolio that mirrors a broader index by holding each of its constituents, but it’s managed just for you. One of the biggest benefits is tax-loss harvesting: the manager can sell certain holdings at a loss to offset gains elsewhere. 

However, over time, many SMAs become “ossified.” After years of tax-loss harvesting, your SMA might end up holding mostly winners and very few positions that can still be sold at a loss. That makes it harder to maintain tax efficiency. And your returns may begin to stray from the index it’s meant to track.  

A 351 exchange can help reset your portfolio, reducing those deviations while keeping your tax advantages intact. 

Exchange Funds 

Exchange funds (not to be confused with exchanged-traded funds) pool shares of individual stocks from many investors. In return, you get a diversified basket of equities. That structure can be appealing if you want to stay invested while diversifying, but it comes with several trade-offs: 

• Seven-year lockup period. You can’t touch your shares for a long time. 

• K-1 reporting. This involves more complex tax paperwork. 
• Lost dividends. Investors often forgo the cash flow they might have relied on from their concentrated stock. 

By comparison, 351 exchanges avoid long lockups, let you keep your dividend income, and provide simple 1099 tax reporting.

Options and Other Techniques 

Some investors use options-based strategies (like collars or prepaid variable forward contracts) to hedge concentrated positions. While these can help manage downside risk, they’re often complex, costly, and not particularly tax-efficient. 

The reality is that no single strategy is a silver bullet. The “right” approach often involves combining techniques — for example, pairing an SMA with a 351 exchange, or using options selectively to manage downside risk and align your portfolio with long-term objectives. 

You might be a strong candidate if: 

1. You hold a large single-stock position. 

Maybe you’ve spent years at a public company and built a large position through stock grants or options. If that one holding now makes up a big part of your net worth, a 351 exchange can help reduce that concentration risk — all while kicking your “tax bill can” down the road. 

2. You have significant unrealized gains. 

If selling would mean writing a large check to the IRS, a 351 exchange gives you an alternative, letting you rebalance and diversify while deferring the taxable gain. 

3. You’re unlikely to receive a step-up in basis anytime soon. 

If your plan doesn’t include passing the stock to heirs for a future step-up in basis, it may make more sense to take action now.  

4. You have older or “ossified” holdings. 

If you have a separately managed account (SMA) or older investment portfolio that’s accumulated years of winners but few losses left to harvest, you may be running into higher tracking error and reduced tax efficiency. Pairing an SMA with a 351 exchange can help reset your portfolio, realign it with your goals, and preserve its tax advantages. 

When a 351 Exchange May Not Be the Right Fit

• If your concentrated holding is relatively small in dollar terms or as a percentage of your total net worth. 

• If you expect a step-up in basis in the near future (e.g., estate planning considerations). 

• If you’re unwilling or unable to meet the diversification thresholds required for participation. 

In short, 351 exchanges are most useful when a single position has grown too large for comfort — but selling would mean a costly tax bill. They give you a way to move forward strategically, without losing ground to taxes in the process.  

So, what does the 351 exchange process typically look like? 

1. Portfolio Review

The process starts with a detailed look at your portfolio, identifying whether you have concentrated holdings or older accounts that might benefit from a reset. The goal is to pinpoint where diversification and tax deferral could make the most difference for you.

2. Tax Analysis

Since the main advantage is tax deferral, your advisor and CPA will analyze your tax picture, including unrealized gains, income levels, and estate planning goals, to confirm that a 351 exchange works with your broader tax strategy. In some cases, gradual selling, gifting, or charitable contributions may be better options.

3. Eligibility and Diversification Check

Next, the compliance test: 

• No single security can represent more than 25% of your contribution. 

• The top five securities together cannot exceed 50%. 

If your holdings don’t meet these thresholds, your advisor may help you combine them with other securities to qualify and meet the IRS diversification rules.

4. Fund Sponsor Coordination

Through established relationships with major asset managers, advisors with access help identify new ETF opportunities that can accept your contributed securities. Because these launches depend on SEC approval, timing can vary — you may not see a full prospectus until shortly before the fund goes live.

5. Execution of the Exchange

Once everything is approved, your securities are transferred into the new ETF, and you receive shares of the new corporation’s stock in return. Your original cost basis carries over — so you’ve effectively diversified your portfolio without realizing immediate capital gains.

6. Ongoing Monitoring

After the exchange, your advisor continues to monitor how the new position fits into your overall plan, making adjustments as your goals or market conditions evolve. For very large positions, multiple 351 exchanges over time may help you fully achieve diversification in a tax-efficient way. 

That’s why working with a trusted advisor is so important. A 351 exchange isn’t a loophole or a quick fix — it’s a sophisticated, IRS-recognized process that requires strategic precision.

At Plancorp Wealth Management, we’ve vetted 351 exchanges through the same evidence-based, rigorous review we apply to every investment solution. If it doesn’t stand up to scrutiny, we don’t recommend it. 

Each transaction is reviewed by our investment committee, cross-checked by our tax experts, and coordinated with established fund sponsors — all to ensure your exchange is executed properly and fits seamlessly into your overall financial plan. 

Most importantly, a 351 exchange is just one tool in a much larger toolbox. For the right investor, it can pave the way to tax-efficient diversification, but it’s not the right fit for everyone.

Our job is to help you weigh the trade-offs, explore the alternatives, and choose the strategy that best supports your goals, tax situation, and long-term financial plan. 

Long story short, a 351 exchange can be a powerful tool for the right investor. But the real value comes from working with an advisor who can weigh all the options, build a plan around your goals, and execute investment strategies that leave you better diversified and better positioned for long-term success. 

If you think you may be a candidate for a 351 exchange, we highly recommend getting in touch with our team. We’ll get started with a private strategy session and evaluate opportunities for diversifying your portfolio and growing your wealth to support your long-term goals.