351 Exchange (Upon ETF Creation)

A 351 exchange allows holders of a semi-diversified portfolio to further diversify via an ETF, while deferring taxes into the future.

Strategy Overview

A 351 exchange allows holders of a semi-diversified portfolio to transfer shares in exchange for a NEW publicly traded ETF that is being launched with the same costbasis. By doing this under IRC 351, you can defer capital gains taxes while positioning the stock for diversification opportunities inside the publicly traded ETF.

Tax Details

With a 351 exchange, you have no capital gains tax at transfer if certain requirements are met. Your basis in the new publicly traded ETF equals your basis in the stock you contributed. Taxes are deferred until you sell your new shares.

To meet the semi-diversified portfolio requirement:

(1) No single holding can be greater than 25%

(2) The top 5 holdings cannot collectively be more than 50% of the portfolio’s net asset value

Let’s say you have $1m of highly appreciated stock. You can create a portfolio with $250k of your highly appreciated stock + $750k of other stocks that are within the confines of the requirements above. You can then exchange this semi-diversified portfolio for a publicly traded ETF, where you now have a higher degree of diversification with the same cost basis ($1m).

Key Benefits

• Tax deferral of highly appreciated stock. A 351 exchange allows you to contribute highly appreciated stock without triggering capital gains, pushing the tax liability into the future.

• Increased Diversification. The new shares of the ETF (likely tracking the S&P 500) that you receive are likely to be more diversified than the current portfolio that you hold.

• Carryover of Cost Basis. Your original cost basis transfers to the new shares received.

Key Considerations/Flags

• Must have a semi-diversified portfolio. A 351 exchange does not allow you to contribute a single highly appreciated stock; it must be a semi-diversified portfolio.

• Does not avoid taxes, only defers them. This strategy does not avoid any taxes; it defers them to a later/future date.

Strategy: When to Consider This and When to Avoid It

🟢 When to Consider This Strategy:

• You have highly appreciated company stock and want to explore diversification without triggering immediate capital gains.

• You want to diversify your highly appreciated stock in a high-income year and want to defer taxes to a lower income year.

🔴 When to Not Use This Strategy:

• You have no need to defer taxes. Either way, taxes WILL have to be paid, so if you want/need immediate diversification, you are better off paying the taxes now.

• You are heavily concentrated in one stock. You will likely not have enough diversification to meet the requirements of a semi-diversified portfolio.