A 351 conversion—the process of transferring appreciated assets into an Exchange-Traded Fund (ETF) without necessarily triggering immediate recognition of taxable gains if all relevant IRS conditions are met—is a compelling strategy for tax efficiency and portfolio modernization. However, this opportunity comes with complexities that require careful planning.

To ensure a successful and compliant transition, here are the top three considerations every investor and advisor should evaluate.

1. Diversification Compliance: The Foundation of Tax-Free Status

For a 351 conversion to potentially qualify as tax-free under IRS rules, the ETF must meet strict diversification standards:

• Single Asset Limitation: No single holding can exceed 25% of the portfolio’s total value.
• Collective Threshold: Holdings over 5% cannot collectively make up more than 50% of the portfolio.

This compliance ensures that the ETF is sufficiently diversified to align with regulatory requirements. Failing to meet these thresholds could disqualify the transaction and result in immediate tax liabilities. Investors should review their portfolios in detail and make necessary adjustments before initiating the conversion.

Tidal Tip: Work with experienced advisors and fund managers to preemptively address diversification issues and maintain compliance throughout the conversion process.

2. Control Requirements: Retaining Ownership Post-Conversion

To satisfy Section 351’s conditions, the original contributors must retain at least 80% control of the ETFs voting power and value immediately following the conversion. This stipulation ensures that the contributors maintain significant ownership and influence over the ETFs operations, potentially qualifying the transaction for tax-free treatment.

Advisors and investors should carefully structure the conversion to preserve this control threshold, particularly in scenarios involving multiple contributors or large, complex portfolios.

Tidal Tip: Early planning and precise calculations are critical to maintaining the 80% ownership requirement without compromising the fund’s operational goals.

3. Accurate Recordkeeping: The Key to Long-Term Success

Recordkeeping is often an underestimated aspect of 351 conversions, but it’s vital for compliance and future tax planning. Each transferred asset’s cost basis and holding period must be meticulously documented, as these details carry over to the ETF shares.

Proper records ensure accurate tax reporting when the ETF shares are eventually sold and can help avoid disputes with tax authorities. Advisors must also coordinate with custodians to facilitate seamless in-kind transfers and maintain transparency throughout the process.

Tidal Tip: Leverage technology and professional fund administration services to streamline recordkeeping and ensure data accuracy.

Learn more about 351 conversions with Tidal

A 351 conversion offers significant advantages, including tax deferral, streamlined portfolio management, and access to the structural benefits of ETFs. However, success hinges on addressing key considerations: meeting diversification requirements, preserving ownership control, and maintaining detailed records.

By partnering with a trusted provider like Tidal, investors and advisors can navigate the complexities of a 351 conversion with confidence. Our expertise can help facilitate compliance and seamless execution, enabling you to unlock the full potential of your portfolio.

Contact us today to explore how we can help you leverage this powerful strategy for tax efficiency and growth.