A 100-Year-Old Tax Rule Called “Section 351” Lets the Rich Turn a Stock Portfolio Into a Private ETF and Put Off the Capital Gains Bill Indefinitely

A retiree walks into a boutique wealth manager with $8 million in NVIDIA, Apple, and Microsoft stock accumulated over two decades. Her cost basis is roughly $600,000. If she sells to diversify, the federal capital gains bill alone lands in seven figures before state tax.

She doesn’t sell and instead contributes the shares to a newly formed exchange-traded fund, receives ETF shares back, and owes zero tax that day. The gain is still there, it just isn’t taxed yet, and if she plans right, it may never be.

Section 351, a Century-Old Nonrecognition Rule, according to Internal Revenue Service

The mechanic, according to the Internal Revenue Service, is Section 351 of the Internal Revenue Code, which lets a taxpayer contribute property to a corporation in exchange for that corporation’s stock without recognizing gain at the moment of transfer. It is old. The Internal Revenue Service traces the modern rule back to the Revenue Act of 1921, written to keep tax out of the way of legitimate business formations, mergers, and reorganizations. What is new is asset managers packaging that hundred-year-old provision as a retail-adjacent product for wealthy investors sitting on concentrated stock.

How the Swap Actually Works

An asset manager forms a new ETF. Wealthy clients contribute appreciated securities into the fund in exchange for shares of the fund itself. Because Section 351 treats the exchange as a nonrecognition event, no capital gain hits Schedule D on the way in, according to Internal Revenue Service.

The tax is deferred. Basis carries over: the ETF shares inherit each investor’s original cost basis, and the built-in gain travels with the shares. Sell the ETF stake later and the gain reappears. Hold until death and current law gives heirs a stepped-up basis, letting the deferred gain vanish entirely. That is the “buy, borrow, die” playbook rewritten for a diversified equity portfolio.

Gates That Keep Ordinary Savers Out

Three restrictions do most of the filtering.

First, diversification. The fund cannot look like a single-stock trust. Contributed portfolios generally must satisfy a 25/50 test: no single position above 25% of the fund, and the top five positions capped at 50%. A retiree whose net worth is 90% one employer’s stock cannot dump the concentrated position wholesale. She has to bring a portfolio that already looks like a fund.

Second, minimums. Sponsors typically want contributions of $1 million and up per client, sometimes several times that, plus legal and structuring costs. The service is marketed to family offices, founders after IPO lockups, and long-tenured executives sitting on decades of RSU gains.

Third, control. The IRS requires that the contributors, taken as a group, control at least 80% of the new corporation immediately after the exchange. The plumbing has to be built for you; you cannot walk up and join.

Who This Actually Serves

The typical customer is a top-percentile investor. IRS Statistics of Income data for tax year 2022 show the top 1% of filers reported 22.4% of adjusted gross income and 40.4% of federal income tax, and long-term capital gains cluster even more sharply at the top. Deferring seven figures of gain matters at that scale. Below it, setup costs and minimums eat the benefit.

Regulators are watching. Some launches pair the Section 351 seed with tax-aware long/short strategies that manufacture losses to layer on top of the deferral, according to Internal Revenue Service. The aggressive versions have drawn IRS scrutiny; the plain-vanilla exchange remains squarely inside the code.

What Ordinary Investors Can Actually Do

Four moves rhyme with the strategy and are available to any brokerage account holder:

• Use ETFs, not mutual funds, in taxable accounts. ETFs use in-kind redemptions to sweep out embedded gains. SPY, the S&P 500 tracker, reports a net expense ratio of 0.0945% and rarely distributes capital gains to holders.
• Harvest losses every year. Realized losses offset realized gains without limit, plus $3,000 against ordinary income, with the rest carried forward indefinitely.
• Mind the 0% long-term capital gains bracket. Married retirees with taxable income under roughly $96,700 pay nothing on qualified gains. Low-income early retirement years and Roth conversion gap years are the windows.
• Plan around step-up. Do not sell the most appreciated lot late in life if heirs will inherit it. Spend from cash and IRAs first, let taxable gains ride to basis reset.

The opportunity cost of selling has climbed with rates. The 10-year Treasury yielded 4.78% on September 4, 2026, so any taxable liquidation now competes with a real, safe alternative. That math is what makes deferral, at every wealth level, worth the pencil.

For anyone weighing a large concentrated position, this is the kind of decision worth running with a fiduciary CPA before the trade, not after. Section 351 is one lever; there are others hiding in the code that quietly drain retirement accounts if you miss them, and we mapped nine of them in a free guide: The Retiree’s Tax Trap Map.

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