351 Exchange – Tax-Free Transfer of Individual Stocks to an ETF

In an effort to simplify and consolidate my portfolio, I recently completed what’s known as a Section 351 exchange in a taxable account. This provision of the Internal Revenue Code lets investors transfer assets—such as stocks and securities—to a corporation without recognizing a taxable gain or loss, provided certain conditions are met.

With help from my financial consultant, I exchanged a portfolio of individual stocks in a separately managed account (SMA), held since 2020, for shares in a new exchange-traded fund (ETF). Because the transaction qualified under Section 351, it was tax-free, and my original cost basis carried over to the ETF.

The SMA portfolio held global growth equities, with both long- and short-term gains and losses. The new ETF—a focused growth fund—owns many of the same companies. In fact, the SMA’s asset manager launched this ETF, offering SMA clients the opportunity to contribute their holdings during its initial seeding via the 351 exchange. I could have included other stocks or ETFs I held elsewhere, but I limited the exchange to the SMA positions.

Since opening the SMA, I’ve tracked every purchase, sale, and dividend in Quicken (dividends were not reinvested). I also managed tax-loss harvesting, instructing the manager to temporarily replace any sold stock with an index fund for 30 days to avoid the wash-sale rule. Keeping the SMA synchronized in Quicken took time and discipline, but it provided useful insight into performance and taxes.

There’s an after-tax advantage to ETFs compared with SMAs. I was provided the following example: assuming an 8% annual return, 20% turnover, and less than 1% in dividends, the ETF structure can deliver roughly a 1-percentage-point annual savings after accounting for fees and taxes. Before the exchange, I harvested stock lots with losses to offset this year’s SMA capital gains.

The exchange itself was efficient—only three business days from the removal of the SMA stocks to receipt of the ETF shares. The brokerage provided detailed tax-lot information, including share counts, cost basis, and unrealized gains and losses. Although Quicken doesn’t have a one-click “351 exchange” transaction, it can be recorded accurately by treating it as a non-taxable security swap, ensuring the cost basis carries over properly. (I followed a process laid out by ChatGPT.)

Investors aren’t locked into the ETF. Once received, ETF shares can be sold, donated, or even used in another 351 exchange. Several new ETFs are now being launched through this mechanism, accepting stocks and other securities from investors across multiple custodians. These funds can offer an efficient way to diversify or rebalance portfolios—say, shifting from concentrated technology holdings to value, international, or fixed-income assets—all while deferring taxes.