Last week the Treasury and IRS issued Rev. Rul. 2026-201 and Notice 2026-622 which in part gave welcome clarity to the rules surrounding the use of 351 Exchanges in the launch of new ETFs. If you are not familiar with the 351 Exchange, it is part of the tax code that allows investors with highly appreciated diversified stock and ETF portfolios to exchange those assets for shares of a newly launching ETF without triggering capital gains taxes. One can carry the cost bases and holding period of the contributed portfolio assuming all conditions are met.
They have been gaining in popularity in the last few years with over 100 launched amounting to about $22B in assets.3 One of the challenges for issuers of ETFs accepting 351 Exchange contributions is that guidance has been relatively vague, so some have adhered to the letter of the law, but abused the spirit of the law and this is where the guidance is helpful.
Brent Sullivan of Tax Alpha Insider put out a podcast called “The abusive §351 is dead: long live routine §351”4 This title is a great summary of the release. Matt Buckin of Exchangifi said “Regulators provided clarity. On one side is legitimate 351 seeding and ETF portfolio management. On the other are transactions built mainly to manufacture tax benefits. Legal and tax advisors have long told ETF sponsors not to accept holdings they don’t plan to hold.”
Much of this surrounds what assets ETF issuers accept via the 351 exchange. Some issuers were accepting securities that did not match the investment strategy of the ETF and flushing them out immediately via the in kind redemption process that does not trigger a capital gain and replacing them with materially different instruments.
Basically, if you are launching an International Micro-Cap ETF, don’t accept a large position in a huge US tech company and expect that you can just slide that out and replace it with the target allocation.
For those already following the spirit and letter of the law, this is not surprising and welcome confirmation of process.
- https://www.ropesgray.com/en/insights/alerts/2026/09/irs-targets-etf-seeding-transactions-and-other-tax-aware-fund-strategies-in-new-guidance
- https://www.irs.gov/pub/irs-drop/n-26-62.pdf
- https://www.bloomberg.com/graphics/2026-etf-351-conversion-tax-dodges/
- https://open.spotify.com/episode/0wcH5gSc4SPaugN9Zj815R
Bio
Eben Burr is president of Toews Asset Management. He serves as a lecturer and coach of applied behavioral finance for Toews’ Behavioral Investing Institute. He assists in training advisors to implement managed risk strategies and build an educational process for managing investor behavior. He lives in NYC with his wife, son, and lots of guitars. Connect with Eben on LinkedIn
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