In this month’s Balance Wealth webinar, Bob Gavlak and Nic Gookin, Chief Investment Officer at Balance Wealth, walked through a planning strategy that may help investors diversify highly appreciated stock positions without immediately triggering capital gains taxes: the 351 exchange.
Many investors eventually run into a “good problem”: they bought a stock years ago, it grew substantially, and now it represents an outsized portion of their taxable portfolio. While that success is worth celebrating, concentrated stock positions can create risk, especially when one company becomes too large a piece of the overall financial picture.
Nic explained why diversification matters, how highly appreciated positions can leave investors feeling “locked up,” and where a 351 exchange may fit alongside other strategies like tax-loss harvesting, charitable giving, adding cash, long-short strategies, or simply selling and paying the tax.
Key Topics Covered
What is a 351 exchange?
A 351 exchange refers to Section 351 of the tax code, which can allow investors to contribute appreciated securities into a newly formed ETF in exchange for shares of that ETF.
Why this strategy is gaining attention now
While Section 351 has existed for decades, investment firms have recently made the strategy more accessible through newly launched ETF structures.
Who may qualify
Nic explained that this strategy generally applies to taxable accounts, such as individual accounts, joint accounts, and many trust accounts. It does not apply to IRAs, Roth IRAs, or 401(k)s, where diversification can typically happen without triggering capital gains.
Which assets may qualify
Stocks and ETFs may generally be eligible. Mutual funds, cryptocurrency, options, derivatives, and cash do not qualify.
The diversification rules
To qualify, the contributed portfolio generally must meet IRS diversification requirements, including limits around how much can be concentrated in a single security or a small group of securities.
How ETFs can help with qualification
Nic explained that ETFs may receive “look-through” treatment, meaning the underlying holdings of the ETF can help determine whether the portfolio meets diversification rules.
How tax lots are treated
One of the most important planning details covered was that tax lots do not simply get averaged together. They can carry over separately into the new ETF, which may preserve flexibility for future planning decisions, including charitable giving or future sales.
The potential bonus strategy
Nic also discussed how, in some cases, investors may be able to use more than one 351 exchange over time. However, he emphasized that repeated exchanges should be approached carefully because of potential IRS scrutiny.
Main Takeaway
Highly appreciated stock can be a sign of successful investing, but too much concentration can create unnecessary risk. A 351 exchange may give certain investors a way to diversify more efficiently, especially when used as part of a thoughtful, personalized planning strategy.
For questions about whether this type of strategy could fit into your financial plan, reach out to the Balance Wealth team.
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This material is purely intended to be general and educational in nature, and should not be construed as specifically-tailored investment, financial planning, tax, legal, or other professional advice. Information and data contained herein is as-of the date of publication, and may be subject to change in the future without notice. Any investment performance referenced is purely past performance, which is no guarantee of any future performance. Nothing contained herein should be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation of any security or other financial product or investment strategy. All investment, tax, and financial planning strategies involve risk that you should be prepared to bear. You are highly encouraged to consult with professionals of your choosing before taking any action based on this material.