A tax strategy once confined to the quietest corners of the wealth-management world has broken into the open, and the U.S. Treasury Department is now weighing whether to rein it in. The maneuver, known as a “351 conversion,” lets an investor sitting on years of stock-market gains fold those appreciated holdings into a brand-new exchange-traded fund without triggering the capital gains tax bill a straight sale would produce.

The appeal is straightforward for anyone holding a concentrated position that has ballooned in value. Selling to diversify means writing a check to the government at the top long-term capital gains rate of 20 percent, plus the 3.8 percent net investment income tax on top. A 351 conversion sidesteps that moment entirely. The investor contributes the stock to a newly formed ETF, receives fund shares in return, and carries the original cost basis forward. No sale, no realized gain, no immediate tax.

The name comes from Section 351 of the Internal Revenue Code, a provision on the books for roughly a century that permits property to be transferred into a corporation tax-free under the right conditions. Applied to ETFs, it comes with guardrails: the contributing investors must hold at least 80 percent of the new fund immediately after the exchange, and the portfolio has to be diversified enough that no single holding tops 25 percent and the five largest stay under half the total. Once the assets are inside the ETF wrapper, the fund’s in-kind trading machinery allows it to rebalance into a broad, diversified basket without kicking off taxable events along the way. The investor ends up diversified, still fully invested, and untaxed.

The strategy has moved well beyond theory. One of the clearest recent examples is a core-equity ETF that launched in February seeded with roughly $540 million in securities, most of it supplied by a single wealthy family looking to shed appreciated shares without realizing the gains. Filings show the roster of participants now includes private-equity billionaire Richard Kayne, and the trend has pulled in large institutional names as well, among them Dimensional Fund Advisors and Baillie Gifford, with Neuberger Berman said to be preparing its own version. Charlotte Hornets owner Gabe Plotkin is also reported to be planning a fund seeded largely with his own holdings.

What turns deferral into potential avoidance is the estate-planning endgame. Because heirs can inherit ETF shares at a stepped-up cost basis, the embedded gain that was never taxed during the investor’s lifetime can vanish altogether when the shares pass on. That is the feature that has drawn the sharpest criticism of the practice as a permanent escape hatch rather than a timing tool.

Regulators have taken notice. Late last year, Treasury officials began signaling interest in the conversions, and by early 2026 the department was in preliminary discussions with the Investment Company Institute and tax attorneys about how it might respond. Among the options floated internally was designating certain conversions “transactions of interest,” a label reserved for deals carrying tax-avoidance potential that triggers heightened IRS reporting. No formal guidance has been issued. In an unusual step, the ICI itself filed a comment letter asking Treasury for clarity, a sign the fund industry would rather have defined rules than open-ended uncertainty.

Congress is circling as well. Senate Finance Committee Ranking Member Ron Wyden, D-Ore., has introduced legislation aimed at limiting access to 351 exchanges within the ETF market. And tax specialists have flagged aggressive uses that could invite an IRS challenge even under current law. Two patterns draw the most attention: “stuffing,” where a fund is packed with highly appreciated shares that have little to do with its stated investment strategy, and “sequential seeding,” where new ETFs are spun up repeatedly for the sole purpose of cycling appreciated stock into tax-deferred wrappers. Either could give the government grounds to recharacterize the deal and impose the tax immediately under the economic-substance doctrine, which lets the IRS disregard transactions that exist mainly to avoid tax.

For now, the conversions remain legal and are spreading fast enough that some advisory firms report a steady stream of pitches from issuers offering to structure them. The open question is how long the window stays open. With Treasury studying its options, the ICI asking for rules, and legislation pending on Capitol Hill, the strategy sits in a familiar spot: a legal edge that works precisely until Washington decides it works too well.

JBizNews Desk | New York, N.Y.

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