Tax Analyst Brent Sullivan on Bloomberg: 351 Exchange ETFs Emerge as a Growing Tool for Capital Gains Deferral

A specific and sophisticated tax strategy is gaining traction among investors, using the launch of new exchange-traded funds as a vehicle to defer or reduce capital gains liabilities. The mechanism, known as a 351 exchange, allows an investor to contribute a portfolio of appreciated securities to a newly created ETF in a tax-free transaction, effectively resetting the cost basis and postponing a taxable event.

Tax analyst Brent Sullivan of Tax Alpha Insider detailed the practice on Bloomberg's 'ETF IQ' with hosts Katie Greifeld, Scarlet Fu, and Eric Balchunas. The strategy hinges on an investor identifying a new ETF with an investment objective that aligns with their own portfolio of highly appreciated assets. By transferring those securities into the fund as part of its creation, the investor can avoid an immediate capital gains tax hit that would occur from a direct sale.

The growing discussion around 351 exchanges signals heightened scrutiny from both tax professionals and regulators. While the practice is a legitimate application of existing tax code provisions, its increased use raises questions about its scale and potential for attracting regulatory attention. For the ETF industry, it represents another complex intersection of product structuring, investor demand, and tax policy, creating both opportunity and risk for fund sponsors and their clients navigating the boundaries of tax efficiency.