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Yes—properly structured Section 351 ETF seed transactions remain potentially viable after the IRS’s September 28, 2026 guidance. The government targeted arrangements that use a contribution of appreciated securities followed by a rapid creation-and-redemption sequence to swap into a materially different portfolio without current gain recognition. It did not declare every 351 exchange invalid, but the boundary between conventional planning and an abusive conversion is not yet fully defined.
What the IRS changed on September 28, 2026
Treasury and the IRS issued Notice 2026-62 and Revenue Ruling 2026-20. The notice asks for comments on novel investment-fund strategies that may produce tax results inconsistent with federal tax rules. It says future guidance could include regulations, additional notices, revenue rulings, listed-transaction or transaction-of-interest treatment, and could apply prospectively or retroactively.
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Revenue Ruling 2026-20 addresses a planned sequence with these elements:
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1Scan for outdated or missing drivers - takes under a minute2Repair Windows errors before they cause bigger problems3Fix the driver behind crashes, sound loss and screen glitches- Investors contribute appreciated securities to a newly formed ETF.
- The ETF issues creation units to an authorized participant in exchange for securities aligned with the ETF’s investment thesis, or cash to purchase those securities.
- The ETF then redeems the units using the investors’ original securities.
The IRS says that arrangement is properly treated as a taxable exchange between the contributing investors and the authorized participant, rather than a qualifying Section 351 contribution to the ETF. In the government’s view, the steps function economically as a portfolio swap, not as a genuine contribution of assets the fund intends to hold.
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What remains potentially eligible for Section 351 treatment
The notice expressly says it does not address, and takes no position on, a Section 351 transaction used to seed a newly established ETF with assets that are consistent with the fund’s investment thesis and are intended and expected to remain in the ETF, absent a substantial change in circumstances.
That distinction is the key to the current answer. A conventional seed transaction is designed to capitalize a fund with the portfolio it is actually supposed to own. A targeted conversion structure is designed around a prearranged exchange that can leave the fund with a substantially different portfolio almost immediately.
Tim Steffen, managing director and director of advanced planning at Baird Private Wealth Management, told InvestmentNews that properly done transactions remain viable, although the line separating legitimate and abusive structures is still developing.
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How a conventional 351 ETF seed is supposed to work
Section 351(a) generally provides nonrecognition when property is transferred to a corporation solely for its stock and the transferors are in control immediately after the exchange. Section 351(e) limits that treatment for transfers to an investment company, which is why portfolio composition and diversification matter.
1. The assets must fit the fund’s stated strategy
The contributed securities should be consistent with the ETF’s investment thesis—not merely convenient assets that an investor wants to exchange away. The fund’s documents, proposed portfolio and operating plan should all tell the same story.
2. The ETF should intend to retain those assets
The IRS’s notice focuses on whether the ETF is expected to keep the contributed property absent a substantial change in circumstances. A prearranged plan to dispose of the assets or use them to obtain an unrelated portfolio creates the central recharacterization risk described in Revenue Ruling 2026-20.
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3. The transferors must satisfy the control requirement
The transferors, taken together, must be in control of the corporation immediately after the exchange. The precise ownership and voting arrangements require transaction-specific legal analysis; an investor cannot assume that contributing property alone establishes the required control.
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The notice explains that diversification is generally measured by having no more than 25% of portfolio value in any one issuer and no more than 50% in five or fewer issuers. These are portfolio-level tests, so a single highly appreciated holding is not the ordinary fact pattern for a qualifying transaction.
Conventional seed versus the targeted conversion structure
| Issue | Conventional Section 351 ETF seed | Structure targeted by Revenue Ruling 2026-20 |
|---|---|---|
| Fit with ETF strategy | Contributed assets match the fund’s investment thesis. | Investors contribute one set of assets while the intended economic exposure is a materially different portfolio. |
| Expected holding period | The ETF intends to retain the contributed assets unless circumstances substantially change. | A rapid creation-and-redemption sequence is arranged in advance. |
| Control and diversification | Transferors must meet Section 351 control rules, and the portfolio must satisfy applicable investment-company diversification limits. | The transaction may be recast if the steps are viewed as a swap that bypasses those requirements. |
| Tax result described by the IRS | Potential nonrecognition if all statutory and factual requirements are met. | Taxable exchange between the contributing investors and the authorized participant. |
| Fund economics | Assets are contributed to capitalize a new fund that will operate with them. | The steps are coordinated to produce a different portfolio without current gain recognition. |
| Regulatory uncertainty | The notice says conventional, long-established planning consistent with congressional intent should be respected. | Further guidance could impose listed-transaction or transaction-of-interest reporting and could be prospective or retroactive. |
Why a single appreciated stock position usually is not enough
Investors often ask whether they can contribute one highly appreciated company holding and receive a diversified ETF without paying capital-gains tax. Steffen said that is not the usual fact pattern because the portfolio must be diversified. A single concentrated position can therefore fail the investment-company diversification analysis even before the IRS examines the timing and purpose of any redemption.
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Practical hurdles also narrow the pool of potential users:
- Minimum investment: Steffen said minimums are usually larger than many clients are willing to commit.
- Limited operating history: A newly launched ETF has no established performance or operating record for an investor to evaluate.
- Portfolio risk: The assets that qualify for seeding must be suitable for the fund’s strategy, not simply the securities with the largest unrealized gain.
- Execution risk: The legal and tax result depends on the entire sequence, agreements, ownership structure and expected conduct—not just the form of the contribution.
Tax deferral is not tax elimination
“This is simply a tax deferral technique. It’s not a tax elimination technique,” Steffen told InvestmentNews. Nonrecognition, when available, postpones the immediate gain; it does not erase the economic gain embedded in appreciated property. A later taxable disposition or other recognition event can still create a liability, and the eventual tax outcome depends on the investor’s facts and the fund’s operations.
That distinction matters when comparing the strategy with simply selling, paying tax and reinvesting. The relevant question is not only how much tax might be deferred, but also whether the new ETF, its costs, concentration limits, liquidity and investment mandate are acceptable after the transaction.
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How large is the 351 ETF market?
More than 100 ETFs have reportedly been seeded in kind under Section 351 since 2021. The Tax Alpha Insider tracker, as reported by InvestmentNews in 2026, counted more than $40 billion in current assets under management. An earlier September 29 InvestmentNews report cited more than $20 billion in launch assets under management for more than 100 ETFs seeded since 2021. Those figures measure different points in a fund’s life—current AUM versus launch AUM—and should not be treated as interchangeable.
What future IRS guidance could mean
The notice says the Treasury Department and IRS intend to target specific abusive transactions, minimize compliance burdens and respect conventional, long-established tax planning consistent with congressional intent. That language is reassuring for ordinary seeding transactions, but it is not a blanket safe harbor.
The consultation’s reported written-comment deadline is October 28, 2026. Until additional guidance is issued, taxpayers and advisers must evaluate whether a transaction’s business purpose, asset selection, expected holding period and sequencing are consistent with a genuine ETF launch rather than a prearranged exchange.
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A due-diligence checklist before considering a transaction
- Map the entire sequence. Obtain every contribution, creation, redemption and investment-management agreement before deciding that Section 351 applies.
- Test the portfolio. Document the ETF’s investment thesis and calculate whether the holdings satisfy the 25%-in-one-issuer and 50%-in-five-or-fewer-issuers diversification measures described in the notice.
- Confirm control. Verify who owns the ETF immediately after the exchange and whether the transferors collectively meet the Section 351 control requirement.
- Ask what the fund will actually hold. Determine whether the contributed securities are expected to remain in the ETF absent a substantial change in circumstances.
- Stress-test recharacterization. Model the consequences if the IRS treats the steps as a taxable exchange, including the timing of gain recognition and any reporting obligations.
- Review the fund itself. Assess minimum investment, liquidity, fees, concentration, governance and the absence of an operating history for a newly launched ETF.
- Get independent advice. Have a qualified CPA, tax attorney or fiduciary adviser review the specific documents and facts. Eligibility and tax results cannot be promised from a general description.
Baird does not offer 351 products, according to Steffen. He said clients and advisers he has walked through the details generally concluded the strategy was not a fit, while noting that this does not mean it can never be appropriate.
Bottom line for investors
The IRS ruling does not kill every Section 351 ETF exchange. It rejects a particular type of prearranged contribution-and-redemption sequence and warns that similar arrangements may face additional guidance or recharacterization. A transaction remains potentially viable when diversified, thesis-consistent assets are contributed to a new ETF that genuinely intends to retain them, the transferors satisfy the control rules and the full structure withstands scrutiny as a fund launch rather than a concealed portfolio swap.
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