For investors and financial advisors managing Separately Managed Accounts (SMAs) with significant unrealized gains, the challenge is clear: how to unlock liquidity and restructure portfolios without triggering tax liabilities. Section 351 of the U.S. Internal Revenue Code provides a potential solution, a tax-deferred conversion of SMA holdings into an Exchange-Traded Fund (ETF). This strategy may defer capital gains but also offers potential operational and structural benefits of ETFs.
Understanding Section 351 Conversions
Section 351 allows investors to transfer appreciated assets, such as 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.
Converting SMA holdings to an ETF through Section 351 offers several compelling benefits:
- Tax Efficiency: Investors may defer capital gains taxes until they choose to sell their ETF shares. This deferral can lead to enhanced long-term growth potential, as more capital remains invested and compounding over time.
- Operational Simplicity: Consolidating multiple SMA accounts into a single ETF simplifies portfolio management. ETFs offer intraday liquidity, transparent holdings, and streamlined reporting, reducing administrative burdens for both investors and advisors.
- Flexibility: ETFs provide the opportunity to implement diverse investment strategies that may be challenging to execute within individual SMAs.
Considerations for a Successful Conversion
While the advantages are significant, executing a 351 conversion requires careful planning and adherence to regulatory requirements:
- Diversification Compliance: The ETF must meet IRS diversification standards, ensuring no single asset exceeds 25% of the portfolio and that assets exceeding 5% collectively remain under 50%. Non-compliance could result in the transaction being non-taxable.
- Control Requirements: Post-conversion, the original contributors must retain at least 80% control of the ETF’s voting power and value to maintain tax deferral.
- Accurate Record-keeping: Maintaining detailed records of the cost basis and holding periods for all contributed assets is essential for tax reporting.
Why Partner with Tidal for Your 351 Conversion
Navigating the complexities of a 351 conversion necessitates expertise and precision. Tidal offers comprehensive white-label ETF solutions, guiding clients through each step of the conversion process:
- Expert Consultation: Our team provides personalized advice, ensuring your portfolio aligns with IRS and SEC requirements, and that the conversion strategy suits your financial objectives.
- Seamless Execution: We manage the intricate details of establishing and launching your ETF, from regulatory compliance to operational setup, allowing you to focus on your investment strategy.
- Ongoing Support: Post-conversion, Tidal offers continuous support, assisting with fund administration and compliance monitoring to help ensure the sustained success of your ETF.
Take the Next Step
Partnering with Tidal can ensure a smooth, compliant, and strategic transition, positioning your investments for enhanced growth and flexibility.
To explore how a 351 conversion can benefit your portfolio, contact Tidal Financial Group today for more information.
