Treasury Weighs Curbing the ETF Trade That Lets the Wealthy Defer Capital Gains

The Investment Company Institute, the trade group representing roughly $45 trillion in fund assets, has formally asked the US Treasury Department for guidance on Section 351 ETF conversions, according to a June 8, 2026 report from Liskow & Lewis, an outside law firm that tracks the filings. The request follows months of quiet discussion in which Treasury officials weighed whether to curtail the strategy or formally flag some conversions as abusive. For investors who have used the technique to diversify out of concentrated, low-basis stock without a tax bill, the outcome will decide whether the door stays open, closes, or simply gets harder to walk through.

What changed

Section 351 conversions let a group of investors contribute appreciated securities to a newly formed ETF in exchange for fund shares, generally without triggering capital gains at the time of the swap. The provision itself dates back decades and was originally written for people forming ordinary corporations. Applying it to ETF launches became a recognizable trend starting in late 2024, and by mid-2026 dozens of funds had used the structure to accept in-kind portfolios instead of cash. According to the Liskow & Lewis account, the Investment Company Institute has met with Treasury officials on at least two occasions this year, and those conversations have included whether certain conversions should be designated a "transaction of interest," a formal label the IRS uses to flag arrangements it views as having tax-avoidance potential. That label does not make a transaction illegal, but it does trigger enhanced disclosure and reporting obligations for everyone involved, including fund sponsors and the investors who contributed shares.

Who is affected

The investors most exposed are the same ones the strategy was built for: people who have held a handful of stocks for years, watched the value climb far above what they paid, and been unwilling to sell because of the tax cost. That group includes long-tenured technology employees, business owners who took stock in an acquisition, and heirs of portfolios that grew after a prior owner's basis carried over. Fund sponsors that have built a pipeline of new share classes around the 351 structure are also watching closely, since a transaction-of-interest label would raise compliance costs and could cool investor demand even if the underlying strategy remains legal.

The after-tax math

A transaction-of-interest designation would not undo an already-completed exchange, but it would change the calculus for a new one. Consider an investor with a $2 million portfolio of 15 stocks carrying a combined cost basis of $500,000, structured so no single holding exceeds the 25% concentration limit and the top five names stay under the 50% combined limit described by Kitces.com. Selling that portfolio outright and reinvesting might trigger roughly $1.5 million of gain; at a combined federal and state rate in the neighborhood of 25% for illustration, that is close to $375,000 in tax paid immediately. Completing a 351 exchange instead defers all of it, keeping the full $2 million invested with the original $500,000 basis carrying over to the new ETF shares. A transaction-of-interest label would not change those numbers directly, but it would require the investor and the fund to file additional disclosure statements flagging the transaction to the IRS, and it could make custodians and advisors more cautious about recommending the structure at all.

Moves to discuss with your advisor

• Whether a pending or recent 351 exchange would fall under any new reporting requirement Treasury adopts, and what documentation to keep on hand.
• Whether the underlying diversification benefit still justifies the fund's expense ratio and any turnover-related distributions if guidance narrows how the structure can be used going forward.
• Alternatives for concentrated positions that might not qualify or that a household prefers not to route through a strategy under active regulatory review, such as exchange funds, charitable remainder trusts, or a multi-year sale schedule.

What to watch

Treasury has not set a public timeline for acting on the ICI's request, and the agency could choose anything from silence to a formal transaction-of-interest notice to a narrower set of operating rules. The Investment Company Institute has argued publicly against a blanket curtailment, pointing to the diversification and cost benefits the structure provides beyond any tax deferral. Investors considering a 351 exchange this year may want to track whether new fund launches slow down, whether sponsors add extra compliance language to their offering documents, and whether the IRS publishes anything in its weekly bulletin naming the strategy directly.

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