Treasury's 351 ETF crackdown turns on whether the converted portfolio stays the same
Treasury limited one Section 351 ETF conversion on Monday and called others potentially abusive, as more than 120 funds use the structure. Advisers who sold it as a tax play now face a harder pitch, judged on how the portfolio is run after the swap.
The Investor · Invest desk
What happened
- Treasury officials had called the conversions "too good to be true" at an industry event, but Monday's move was the first regulatory action taken against them.
- More than half of the funds using the structure launched within the past year, which works out to more than 60 new funds in twelve months.
- The guidance does not say how long a manager must wait after a conversion before a change to the portfolio counts as a reasonable move.
- Treasury will take public comment on the targeted transactions, and on others it says deserve similar treatment, until the end of October.
- Baird's Tim Steffen still calls the conversion a legitimate strategy but says he would hesitate to promote it until the IRS spells out the guidance's scope.
Why it matters
- What it limits constraint With no safe period stated, a manager who rebalances a converted portfolio learns only after the fact whether the move was reasonable, so the cautious course is to change little.
- What doesn't add up contradiction One account treats diversification as the protected use while Chou rules out diversification by planned disposal, and RIA funds built to cut concentration risk sit where those readings split.
- Who has to decide decision Advisers who pause new conversions until the scope is clear have to pick substitutes, and Steffen points them to opportunity zone funds and direct indexing.
- What it sets up precedent Box-spread ETFs and funds that sidestep dividend income by flipping between ETFs were flagged alongside 351s earlier this year, so Monday's test gives Treasury a template for them.
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Rick Wedell, president and chief investment officer of RFG Advisory, describes the guidance as a continuity test. He said the structure now requires that "whatever your contribution portfolio is and however you were managing that in the past, when you move it into the new ETF structure, you need to continue to do whatever it was that you were doing in the past with that portfolio" [4]. The case he expects the IRS to pursue is the investor who pools assets, completes the exchange, then quickly sells the portfolio and buys something else, paying no tax on the repositioning [5].
Section 351 lets appreciated assets move into a new vehicle without an immediate capital gains bill, provided the fund meets certain requirements [3]. Treasury's objection, in its statement, is to where some investors end up: they "purportedly avoid recognition of the built-in gains in their securities while effectively exchanging those securities for an indirect interest in an ETF with a materially different portfolio" [12].
Shang Chou, co-founder of the multi-family office Dishmi Capital, draws the line at intent. A "pre-planned idea to dispose of those assets" is "going to be a no-go going forward," he said [7]. Tim Steffen, director of advanced planning at Baird Private Wealth Management, does not expect the IRS to shut the structure down, but said "they're definitely going after the most egregious abusers of it" [20].
Wedell was blunt about advisers who sold the product on taxes [14]. "I think for certain players that were purely marketing this as a tax avoidance strategy, that sale becomes much harder, and they're going to want to think about whether or not they want to go down that path," he said [14]. I think the exposure runs wider than the marketing. WealthManagement's account places investors who convert for diversification, while continuing to manage the portfolio, mostly outside the IRS's sights [6]. Yet the RIA launches it cites this year, from Ritholtz Wealth Management and Dynasty-affiliated N10 Holdings, were built to mitigate concentration risk [18]. Turning one large position into many looks like the materially different portfolio Treasury described [12], and Chou's no-go covers diversification reached through planned disposal [7].
The counter-case is what Chou called "well-behaved 351s," funds whose contributed assets already fit the ETF's core strategy [8]. He set the MIG Core ETF, which took in assets from the Hot Pocket empire, against "ETF firms looking to launch S&P 500-tracking ETFs and willing to take in diversified baskets" [17]. If the Ritholtz and N10 funds accepted only contributions that matched their strategies, they sit on his safe side; the reporting does not describe how either fund handles contributions [18].
This view is wrong if the text Treasury issues after its comment period [13] treats a gradual sell-down of a contributed concentrated holding as ordinary management.
Wedell expects "a little bit of a chilling effect on the industry." He added: "And, candidly, I think that's what the IRS wants" [15].
What to watch
- Whether the text Treasury issues after the end-October comment close sets a period during which a converted portfolio must be run as before.
- Comment letters from sponsors of concentration-risk 351 ETFs, including the Ritholtz and N10 funds, describing how they handle contributed positions.
- Whether box-spread and dividend-flipping ETFs get their own notice under the same substance test.
Information, not investment advice. This story is general information about companies and markets, drawn from cited reporting. It is not a recommendation to buy, sell or hold any security; check the cited sources before acting.
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- [1]
The Treasury on Monday limited one 351 conversion transaction involving an ETF and flagged several others.
- [2]
The government signaled its intention to limit some so-called 351 conversion funds, which it called "potentially abusive."
- [3]
Section 351 allows investors to move appreciated assets into a new vehicle without immediately paying capital gains taxes, provided the new fund meets certain requirements.
- [4]
Wedell said the guidance requires that "whatever your contribution portfolio is and however you were managing that in the past, when you move it into the new ETF structure, you need to continue to do whatever it was that you were doing in the past with that portfolio."
- [5]
According to Wedell, the IRS is targeting investors who pull assets into one vehicle, complete the ETF transaction, and quickly sell the portfolio and buy something else, avoiding taxes during the repositioning.
- [6]
Advisors and investors who use 351 conversions to move portfolios into an ETF as a diversification strategy, while continuing to manage the portfolio, may not be in the crosshairs of the IRS guidance.
- [7]
Shang Chou, co-founder of multi-family office Dishmi Capital, said going in "with a plan to skirt out on the capital gains tax to get diversification with this pre-planned idea to dispose of those assets" is "going to be a no-go going forward."
- [8]
Treasury's language seems to leave a window for what Chou called "well-behaved 351s," funds that make use of assets already aligned with the ETF's core strategy.
- [9]
Earlier this year, Treasury officials flagged 351 conversions along with box-spread ETFs, products that offset ordinary income, and funds avoiding dividend income by flipping between other ETFs.
- [10]
Treasury officials had called 351 conversions "too good to be true" at a recent industry event, but until Monday no regulatory actions had been taken.
- [11]
Funds that use the 351 conversion strategy now number over 120, with more than half of those launching in the past year.
- [12]
Treasury's statement: "Investors purportedly avoid recognition of the built-in gains in their securities while effectively exchanging those securities for an indirect interest in an ETF with a materially different portfolio."
- [13]
The government will seek public comment on the transactions it targeted and on others it said should be regulated similarly, with the comment period closing at the end of October.
- [14]
Rick Wedell, president and CIO of RFG Advisory: "I think for certain players that were purely marketing this as a tax avoidance strategy, that sale becomes much harder, and they're going to want to think about whether or not they want to go down that path."
- [15]
Wedell: "I think that it might have a little bit of a chilling effect on the industry. And, candidly, I think that's what the IRS wants."
- [16]
The IRS does not clarify how long advisors would have to wait before adjusting their portfolios for the moves to be deemed reasonable.
- [17]
The MIG Core ETF took assets from the Hot Pocket empire earlier this year and put them into the ETF structure; Chou said: "I would contrast that with ETF firms looking to launch S&P 500-tracking ETFs and willing to take in diversified baskets."
- [18]
This year, RIAs including Ritholtz Wealth Management and Dynasty-affiliated N10 Holdings have launched ETFs to mitigate concentration risk.
- [19]
Tim Steffen, director of advanced planning at Baird Private Wealth Management, said the conversion remained "a legitimate strategy" after the guidance but he would be hesitant to promote it as an RIA until the IRS detailed the guidance's scope.
- [20]
Steffen: "We don't know how far the IRS is going to push this ruling. Are they going to just completely try and shut these things down? That doesn't seem like the case, but they're definitely going after the most egregious abusers of it."
- [21]
Steffen said opportunity zone funds and direct indexing could fill similar gaps for advisors wary of recommending 351 conversions after the guidance.
- [22]
More than 60 of the funds using the 351 conversion strategy launched in the past year.
Sources
2 independent publishers whose own reporting we read for this story.
- thedailyupside.comWhy the Treasury Is Cracking Down on 351 Conversion ETFs
1 article · September 29, 2026
- wealthmanagement.comFollowing IRS Guidance, Compliance Experts Caution RIAs on Section 351 ETF Conversions
1 article · October 1, 2026
Topics and entities
Topics
- Wealth management compliance
- Section 351 ETF conversions
Entities
- Ritholtz Wealth Management
- Section 351 of the Internal Revenue Code
- Baird Private Wealth Management
- Internal Revenue Service
- US Department of the Treasury