Tax season is here, and for many investors, that means finding ways to keep more of their money. If you’re holding highly appreciated stocks or a dividend-heavy portfolio, you know the challenge of managing capital gains taxes while preserving your investments.
For those using separately managed accounts (SMAs), the burden is even greater, as frequent trading and rebalancing often lead to a disturbing tax bill.
But what if you could reduce your tax exposure without selling your holdings?
Enter 351 conversions, a powerful strategy that allows investors to transition their SMA assets into an ETF wrapper without triggering immediate capital gains taxes.
How Do 351 Conversions Work?
Section 351 of the Internal Revenue Code allows investors to transfer appreciated assets, like stocks or securities, into a newly formed ETF without incurring immediate taxable events.
The ETF inherits the cost basis and holding period of the transferred assets, preserving their tax characteristics.
This mechanism, often referred to as a “351 exchange,” transforms locked-up SMA portfolios into a modern, efficient, and flexible investment vehicle.
Step-by-Step Breakdown of a 351 Exchange
Here is how a Section 351 ETF conversion works:
- Asset Transfer: Highly appreciated securities from an SMA are contributed to a newly created ETF.
- Cost Basis & Holding Period Retention: The ETF inherits the original cost basis and holding period of the contributed securities.
- Tax Deferral Benefits: No immediate capital gains taxes are triggered upon conversion.
- Continued Market Exposure: Investors maintain exposure to the market within a more tax-efficient vehicle.
For example, an investor with $1 million in highly appreciated stocks within an SMA would typically face a significant tax burden upon selling. A 351 conversion allows them to transfer these assets into an ETF, preserving their tax position while gaining potential liquidity and tax efficiency.
Why Asset Managers Are Taking Notice
While SMAs offer customization, frequent trading to maintain portfolios often leads to tax inefficiencies.
In contrast, ETFs provide significant tax advantages through their in-kind creation and redemption process, allowing portfolios to rebalance without triggering taxable events.
This mechanism lets managers adjust positions by transferring securities to authorized participants rather than selling them, deferring capital gains.
Investors only incur taxes when they sell ETF shares, which can further enhance after-tax returns.
Beyond tax efficiency, ETFs offer superior scalability compared to SMAs.
Managers can implement a single strategy for thousands of investors through one fund, streamlining operations and reducing costs compared to managing multiple individualized SMAs.
This scalability can be further amplified by the ETF’s broader distribution and marketing reach.
ETFs are listed on major exchanges and accessible through a wide range of brokerage platforms, enabling asset managers to reach both retail and institutional investors without the constraints of SMA account minimums or direct advisory relationships.
The combination of tax efficiency, operational scale, and widespread accessibility makes ETFs an attractive solution for SMA managers seeking to reduce tax burdens while growing their assets.
As more investors and financial professionals seek innovative tax solutions, Section 351 conversions are quickly emerging as a strategic tool that can benefit a wide range of market participants.
Why Partner with Tidal for Your 351 Conversion
Navigating a 351 conversion requires sophistication and experience, and Tidal Financial Group provides comprehensive white-label ETF solutions to guide you through every step.
Our team offers consultation to ensure your portfolio aligns with IRS and Investment Company Act requirements while tailoring the conversion strategy to your financial goals.
We handle the complexities of ETF establishment, from regulatory compliance to operational setup, so you can focus on your investment strategy.
Even after the conversion, Tidal provides ongoing support, assisting with fund administration and compliance monitoring to help your ETF seek long-term success.
Contact Tidal Financial Group today to explore how a 351 conversion can optimize your portfolio.
